Things Fall Apart (Part 2)

Tony Soprano stares at you menacingly

Tony Soprano: My estimate, historically? Eighty percent of the time it ends up in the can like Johnny Sack. Or on the embalming table at Cozzarelli’s.
Bobby Bacala: Don’t even say it.
Tony Soprano: No risk, no reward.
Bobby Bacala: I mean, our line of work, it’s always out there. You probably don’t even hear it when it happens, right?
― The Sopranos, “Soprano Home Movies” (2007)

I’m going to jump right into this sequel to Things Fall Apart (Part 1), without a heavy recap of that note. The skinny recap is that if you have a two-party political system with high-peaked bimodal electorate preferences, as the United States began to develop in 2014 and has now fully formed, there are no winning centrist politicians and no stable centrist policies. Instead you have – politically speaking, at least – what Yeats called a widening gyre, where a steady stream of extremist candidates, each very attractive to their party base, pull the overall electorate into a greater and greater state of polarization. In other words, if you enjoyed the choices America had in the 2016 presidential election, you’re gonna love 2020.

Just as our politics are falling apart, our portfolios are falling apart, too.

It’s a different kind of falling apart. A less urgent kind of falling apart. Our current market equilibrium is not a widening gyre. It’s something else, which I’ll elaborate on in a second, where our prevalent emotions are bland disappointment and ennui, not urgent fear and loathing like in our political lives. If the signature image of Things Falling Apart in our modern political context is an enraged Tony Soprano pointing a gun at one of Phil Leotardo’s crew, the signature image of Things Falling Apart in our modern investment context is a weary Tony Soprano sitting at that diner in the very last episode, thinking that everything is … okay … definitely not great, but okay, totally oblivious to the reality of how his life has actually already fallen apart, how lethal decisions have been made away from him in ways he cannot observe or control, how his life is literally about to fade to black in 3 … 2 … 1.

The doomed-but-doesn’t-know-it Tony Soprano portfolio isn’t infamous. It’s not a meme. It’s not the public pension plan that is so dramatically underfunded that it contemplates selling billions of dollars in taxable bonds so that it can lever up in the equity market after a nine-year bull run. It’s not the 25-year-old who put the $30,000 he inherited from grandma into crypto because you gotta take chances when you’re young, right?

No, the Tony Soprano portfolio is the private endowment that has done … okay, I guess … but more because operating draws have gone down over this nine-year expansion than because investment performance was good. It’s the IRA that is … up a bit, yeah … but somehow always seems to zig when it should’ve zagged, so that it lightens up at the bottom of every two-week swoon and goes all-in in months like this January. It’s the wirehouse model portfolio that has done everything right in its analysis and its diversification and yet STILL underperforms the S&P 500 every year. Every. Freakin’. Year.

The Tony Soprano portfolio is, I would guess, 95% of us. What drives our disappointment? For a decade now …

  • It is a fact that NONE of us have done as well in our individual real-life portfolios as ALL of us have done in aggregate hypothetical indices.
  • It is a fact that Value has waaay underperformed the S&P 500.
  • It is a fact that Trend has waaay underperformed the S&P 500.
  • It is a fact that Quality has waaay underperformed the S&P 500.
  • It is a fact that Emerging Markets have waaay underperformed the S&P 500.
  • It is a fact that Real Assets have waaay underperformed the S&P 500.
  • It is a fact that Hedge Funds have waaay underperformed the S&P 500.
  • It is a fact that smarts and experience of every sort have waaay underperformed the S&P 500.

And if that weren’t enough, here’s the kicker that’ll get everyone mad at me, because it challenges the central tenet of the Church of Modern Portfolio Theory.

It is a fact that diversification has failed us for a decade.

The entire edifice of diversification and Modern Portfolio Theory is built on a simple and powerful idea – that it is meaningful to talk about uncorrelated asset classes and factors with positive expected returns. It’s built on the belief that all of these Things we call asset classes or factors will work over the long haul, but not all of them will work all of the time or in lockstep with each other, so you’re (much) better off owning a mix of these Things rather than just one of these Things.

Put another way, well-diversified portfolios work great in a widening gyre.

But our current market equilibrium is the opposite of a widening gyre. Where our politics have moved from a roughly single-peaked distribution of electorate preferences to a bimodal distribution, so that there is no effective center, our markets have moved from a multi-modal distribution of investor preferences to a single-peaked distribution, so that it’s all US large-cap stocks all the time.

If our politics are a widening gyre, our markets are a black hole. In both cases, resistance is futile. Fight the political centrifuge spinning you into the extremist arms of a two-party system … and you are left behind as an impotent “centrist”. Fight the investment gravity pulling you into passively managed large-cap US stocks … and you are left behind as an impotent “diversifier”.

Here’s the bottom line for how Things Fall Apart in the widening gyre of modern politics. In a two-party system with high-peaked bimodal electorate preferences:

There is no winning centrist politician.
There are no stable centrist policies.

And here’s the bottom line for how Things Fall Apart in the black hole of modern investing. In a multi-asset class market with high-peaked unimodal investor preferences:

There is no winning diversification advocate.
There are no outperforming diversified portfolios.

Sorry.

I can’t overemphasize how damaging the failure of diversification is to both our portfolios and the stability of our financial advisory system. As both investors and advisors we have put our faith in the power of diversification, and when that Greater Power deserts us we are left open and exposed. We are all Tony Soprano sitting in that diner, aware that something is not quite right, but also not quite able to put our finger on it. So we go on about our business. We order a basket of onion rings. And then it happens.

The bullet for so many smart and competent and well-diversified portfolios is the next recession. Why? Because these portfolios have not made nearly enough money in this long-running bull market to achieve their owners’ investment goals over an investment cycle. A 20% down move in the S&P 500 index would hardly make a dent in that hypothetical price series. But for a real-life portfolio that’s up half that … maybe a third of that … down 20% is a disaster.

The bullet for so many smart and competent and well-diversified financial advisors is also the next recession. Why? Because your clients will tolerate an underperforming theology in their investment lives so long as they are doing okay in their non-investment lives. Begrudgingly. Complainingly. For the most part. But the thing about recessions is that they’re not just a market phenomenon, they’re also a real-life phenomenon where jobs are lost, businesses are strained, and debts come due. Your clients have zero tolerance for disappointment in both their investment AND their non-investment lives. Zero. So unless you’re making money for your clients when the next recession hits, and that’s NOT what that well-diversified wirehouse model portfolio will do, then you’re going to lose clients. Because no one ever thanks a financial advisor for losing money, and you’re already on thin ice.

Here’s the thing about recessions.

Just like the bullet that gets Tony Soprano in the end, you never hear it coming.

Anyone who tells you otherwise is either kidding you or kidding themselves. I mean, we can’t even identify a recession when we enter one, much less predict the timing of the next one. (Seriously, the official adjudicators of recession dates – the National Bureau of Economic Research – always backdate the start of a recession to several months before we first realize we’re in a recession.)

Will there be another recession? Yes. Does anyone know when that recession will happen or how severe it will be? No. If you get nothing else out of Epsilon Theory, get this: there is no algorithm for predicting anything long-term in macroeconomics, there is only non-algorithmic estimation for short-term events. In investor life as in mobster life, the bullet always comes for us eventually. We just can’t predict when.

Wheee! Well, Ben, as usual you’re a total downer. And we didn’t get the usual quota of movie lines, so this is shaping up to be even less enjoyable than usual, if such a thing is imaginable. I don’t suppose there’s anything we can, you know, maybe DO about all this to improve our situation?

Well, yes. Yes, there IS something we can DO about all this, as both investors and as citizens. Maybe not to rekindle some Golden Age, but at least to improve our chances above the 20% that Tony Soprano figures as the odds of avoiding prison or a violent death. To mark out that path, though, first I need to cut through what I think is the origin story for our sorry state of affairs.

What links the widening gyre of politics and the black hole of markets? They’re caused by the same thing. They’re what happens when emergency government action to rescue the financial system from political ruin becomes permanent government policy to use the financial system for political gain.

They’re what happens when an emergency QE1 becomes a permanent policy of QE2 and QE3 and QE Forever-and-Ever-Amen, not just in the US but (even more so) in Europe and Japan. They’re what happens when an emergency bank recapitalization becomes a permanent policy of Get Out of Jail Free and interest on reserves and consolidation and Treasury-backstopped debt. They’re what happens when central banks buy $22 TRILLION of stuff.

Central banks don’t care about Value. Central banks don’t care about Trend or Quality or anything else that rewards “good” investments and punishes “bad” investments. No, all they care about is lifting the price of ALL financial assets, which means – let’s be real here – if central banks have a bias on Quality, their bias is to protect low quality companies. Particularly European low quality banks.

Every policy decision made by China and Europe and Japan and the US in the wake of the Great Financial Crisis was made with a singular goal in mind – to prop up and inflate financial asset prices. Originally, it was to keep the status quo financial system from imploding. But soon after … and still now … it was to keep the status quo political system from imploding. What started as an entirely laudable effort to keep capital markets from collapsing became an entirely problematic effort to turn capital markets into political utilities. This has been a Team Elite goal since at least 1997.

You can see this effort most clearly in the relationship between U.S. household net worth (how rich we are) versus U.S. GDP (how much our economy has grown). I created these charts with data that the Fed has collected on a quarterly basis since 1951. They’re, ummm, kinda crazy.

Here’s the full relationship since 1951. To be clear, both data sets are nominal (meaning neither is adjusted for inflation), measured in exactly the same units – billions of US dollars – and normalized at 100. That’s an excellent way to make an apples-to-apples growth comparison in these circumstances, so don’t @ me about semi-log charting. Also to be clear, the Fed’s Household Net Worth category includes nonprofit organizations, so it includes the assets of pension funds (but not social security).

For 46 years, from 1951 to 1997, we were no more and no less rich than our economy grew. Which makes sense. That’s the neutral vision of monetary policy, where you’re not trying to pull forward future growth through leverage and easy money in order to create more wealth today. For the past 20 years, however, we have had a series of wealth bubbles – first the Dot-Com bubble, then the Housing Bubble, and today the Financial Asset Bubble – that have made us (temporarily) richer than our economy grows.

And yes, that’s what a bubble IS … it’s when you’re richer than your economy grows. Can you do it? Sure! Here’s the proof. But can you keep it?

If I could ask Alan Greenspan one question, because he’s the guy who started all this “wealth creation” effort, it would be this: do you think it’s possible for a country to be long-term richer than it grows, and did you talk with the White House about this? Okay, that’s two questions. Sue me. Same questions for Bernanke, Yellen, and Powell. My guess on answers: “Define long-term.” and “Define talk.”

So what’s the problem with being richer than you “should” be? The problem is how those riches are distributed. The problem is that the road to hell is paved with good intentions, sure, but even more so with hubris and post hoc rationalizations. Here’s a 2016 chart from Torsten Slok at Deutsche Bank that illustrates what I’m talking about.

Because financial assets are primarily held by the rich – and by the rich I’m not even talking about the 1%, but the 1/10th of 1% – a bubble in stocks and bonds primarily works to the benefit of the very rich at the expense of the non-rich. The well-off to merely-rich (the top 9.9% of US households by income) own pretty much the same share of US household wealth throughout this ONE HUNDRED YEAR DATA SERIES. All of the action is a give and take between the top 1/10th of 1% in US households and the bottom 90%.

And before everyone at the Hoover Institution has a fit … did the 1997 Greenspan Fed’s bubble-blowing start the wealth redistribution from the non-rich to the very rich? No. Rock-bottom wealth ownership by the very rich coincided roughly with the Jimmy Carter administration, and it’s been a nice ride for the 1/10th of 1% ever since Ronald Reagan came to the White House. Is it the same US households in the 1/10th of 1% by income over the past 30 years? No. There’s still more income (and wealth) mobility in the US than pretty much any other country. Does it make a difference for questions of wealth that social security exists today and didn’t in the 1930s. Yes, it makes a difference.

But I’m not trying to say that wealth inequality per se is a bad thing or a good thing. I’m not trying to make a close comparison between the meaning of wealth inequality today and wealth inequality in the 1930s. What I’m saying is that wealth inequality in 2018 is greater than it has been in 3+ generations. I’m saying this is a fact. I’m saying that wealth inequality has been exacerbated by the inflation of financial asset prices. I’m saying that if you don’t think this is a problem for political fragmentation … well, then you’re just not paying attention.

But wait, there’s more. This aggregate picture doesn’t do justice to how wealth inequality is experienced in America. Why not? Because of debt, particularly student debt.

If you’re young in America, you don’t feel the wealth inequality that bears down in truth and in spirit on the old non-rich. You don’t feel the wealth inequality because you have unlimited credit to live in a collegiate or graduate school bubble. If you’re young in America you FEEL RICH even as you BECOME POORER. This is not an accident. It is part and parcel of the widening gyre of American politics and the intentional use of the financial system to buy off young Americans and their adult parents. Ditto with Medicare buying off old Americans and their adult children. All while making the very rich very richer.

Okay, so there’s a common core for both the widening gyre of politics and the black hole of markets. But how does this move us from description to prescription? How does this put us on a path where we can DO something to improve our lot?

Let’s go back to that definition of diversification. Let’s go back to that central assumption of Modern Portfolio Theory that the investing world is made up of meaningfully different Things we call asset classes and factors, that all of these Things will work over the long haul, but not all of them will work all of the time or in lockstep with each other, so you’re (much) better off owning a mix of these Things rather than just one of these Things.

What if it’s really just one Thing?

Or rather, what if there’s a New Thing – call it the intentional policy creation of global wealth bubbles through insanely easy credit and, most recently, $22 trillion in outright asset purchases – that DID NOT EXIST when Harry Markowitz was calculating efficient frontiers and all that? What if this New Thing is so big and so powerful, what if it exudes so much gravity, that it has altered the basic geometry of our political and economic systems?

In both our political lives and our investing lives, we are prisoners of the Three-Body Problem.

What is the “problem”? Imagine three massive objects in space … stars, planets, something like that. They’re in the same system, meaning that they can’t entirely escape each other’s gravitational pull. You know the position, mass, speed, and direction of travel for each of the objects. You know how gravity works, so you know precisely how each object is acting on the other two objects. Now predict for me, using a formula, where the objects will be at some point in the future.

Answer: you can’t. In 1887, Henri Poincaré proved that the motion of the three objects, with the exception of a few special starting cases, is non-repeating. This is a non-predictable system, meaning that the historical pattern of object positions has ZERO predictive power in figuring out where these objects will be in the future. There is no algorithm that a human can possibly discover to solve this problem. It does not exist.

This is the foundational statement for a new path through the investing and political wilderness:

Geometry is not true, it is advantageous.

It’s not that diversification and Modern Portfolio Theory and Markowitz and all that is wrong in the sense that there’s a mistake in the math. It’s that when the geometry of our world changes enough, then these elegant and smart constuctions we have made to make sense of the prior geometry are no longer particularly advantageous. I say this not to bury diversification, but to rehabilitate it. I say this because diversification as a tool is extremely useful. Diversification as a religion … not so much.

The path forward is to call things by their proper names, even if that means making painful admissions like … ummm, sorry, but Emerging Markets is not a Thing. What you’ve been calling “Emerging Markets” is just one of many shadows of Big 4 monetary policy. So your well-diversified portfolio that has an “asset class” slot for Emerging Markets? You’re going to have to rethink that. You’re going to have to rethink a lot of things.

Ditto with our path forward as citizens. We’re going to have to rethink a lot of things.

And unfortunately, there is no Answer waiting for us at the end of the rainbow, no algorithm or equation or religion or anything else. That’s life in the Three-Body Problem. A “general closed-form solution” does not exist. It’s just math, as the cool kids say. What there is, though, is a Process. And that will be enough.

PDF Download (Paid Membership Required): http://www.epsilontheory.com/download/15649/

This is Part 2 of a three-part series. Next, what do we DO about all this, as both investors and as citizens? What is the Process for living safely in a Three-Body Problem? It’s not an Answer, because there is no Answer. But it is a start.


Good Job!

Every dog needs a job. It’s how they make sense of their place in the pack. It’s the key to a Good Dog.

You don’t have to tell dogs what their job is. They tell you. Maggie the German Shepherd? Her job is to protect. Sam the Sheltie? His job is to herd. Not sheep, of course, because that would be too useful. Nope, just squirrels. Turns out it’s not easy to herd squirrels, but that doesn’t stop our “special” dog from giving it his all, every day, rain or shine. Eco the Golden Retriever, pictured above? His job was to love, which he did with grace and abandon for 12 years. Rest in peace, old friend. You were a Good Dog, and I miss you.

A dog knows perfectly well when she’s done a Good Job. You can see it in her gait, in her tail, in her ears … everything about the way she carries herself says, “yep, I done good. did you see how good I done? ‘cause I done good.” Conversely, a dog also knows when she hasn’t performed up to snuff. The hangdog look is a real thing. A dog knows honor and a dog knows shame, and there is no more important example that any animal can set for us poor benighted humans.

Why? Well, this is the money quote from Sheep Logic:

Because with no sense of shame there is no sense of honor. There is no mercy. There is no charity. There is no forgiveness. There is no loyalty. There is no courage. There is no service. There are no ties that bind us as citizens, as fellow pack members seeking to achieve something bigger and more important than our ability to graze on as much grass as we can. Something bigger like, you know, liberty and justice for all.

Unlike dogs, humans have a hard time knowing whether or not they’ve done a Good Job. We consistently overestimate our competence at tasks, and when we fail, we evince befuddlement — as if we’re looking for the Restore Saved Game function — rather than remorse or apology. We humans are more Yogi Bear than Lassie.

It’s a widespread behavioral phenomenon at every age and demographic category. But it’s endemic in the young.

I think our notions of what it means to do a Good Job are so stunted for three reasons.

We’ve trivialized honor.

We’ve personalized shame.

We’ve redefined pride.

We trivialize honor through our constant celebration of mere engagement as some sort of actual achievement. We give ourselves and our children these faux “Certificates of Achievement” in one form or another all the time, and once you start looking for them you will see them everywhere.

This is how the Nudging State and the Nudging Oligarchy bring us into the fold. This is how they neg us.

This is how our children become Industrially Necessary Eggs.

We personalize shame by attaching it to identity rather than to behavior. Shame over behavior is ephemeral and corrective. Shame over identity is existential and utterly self-destructive.

The personalization of shame is a merciless goal of the Nudging Oligarchy because we will pay any price to “fix” ourselves. And our children are their primary targets.

Wait, your body isn’t “perfect” like a Victoria’s Secret model? What a shame. But don’t worry, we can help you with that.

We redefine pride when we confuse it for participation and belonging, when we treat it as the opposite of shame rather than what it really is — the foremost of the Seven Deadly Sins.

Like honor and shame, pride has been reattached from behavior to identity by the Nudging State and the Nudging Oligarchy. Like honor and shame, our children are their primary targets.

As Hieronymus Bosch knew well, the demon holding up the mirror of Pride isn’t a fable. The demon is us.

We’ve turned honor into a cheap candy, shame into an existential identity crisis, and pride into a virtue.

  • No wonder hospital admissions for suicidal teenagers have doubled over the past ten years.
  • No wonder our girls cut themselves and our boys shoot themselves.
  • No wonder my Twitter timeline is, day in and day out, a dumpster fire.
  • No wonder our 2016 election was a Sophie’s Choice.

By the way, the right answer to a Sophie’s Choice is NO. The right answer to an impossible dilemma is simply this: Homey don’t play that game.

Whee! I bet you’re a real hoot at cocktail parties, Ben. But can we come back to Planet Earth now?

Yeah, sorry about that. Actually, sorry not sorry. But in any event we’ve got to answer this question:

So what DOES it mean to do a Good Job?

Here’s what it means to any self-respecting dog. Which is to say, here’s what it means to all dogs:

You know what your job is.

The job is in service to the pack.

You do the job better than the average dog.

That’s it. That’s the Good Dog’s definition of a Good Job. Like all old wisdom, it’s deceptively simple. Like all old wisdom, it’s applicable across time and endeavor. This is an algorithm, by the way.

I’ll discuss two applications of the Good Dog’s definition of a Good Job in this essay: professional sports and professional investing. In both fields, there’s a LOT of money at stake with answering our question du jour — what does it mean to do a good job? — and in both fields there’s a clear notion of what “the pack” represents — the team in professional sports and the portfolio in professional investing. Given these similarities, it surprises me that there’s not a commonly held language to address the issue.

I think that professional sports is actually more advanced in their language on this than professional investing, or at least more cohesive, so I’ll start there. This is particularly true in the major professional sport most similar to professional investing in terms of its research methodology and sheer number of observable score/price events — baseball.

The modern methodology of baseball analysis goes by the name sabermetrics, coined by the Godfather of modern baseball statistics, Bill James, and named after the Society for American Baseball Research. I’m not sure if my dad started getting the Bill James Abstract in 1980 or 1981, but it was definitely before James hit the (well-deserved) big time in the mid-80s. In his own way, I’d say that Bill James has been the most influential data scientist in the world over the past 40 years. Certainly he’s had a huge impact on my career. Many others who work with data for a living, like Nate Silver, say the same thing.

The central question that Bill James set out to answer in the late 1970s is the Good Job question: You say that Ted Williams was a great baseball player. How do you know? Compared to who? What does that statement even mean? What’s the relationship between the greatness of Ted Williams and the performance of the Boston Red Sox?

These are exactly the questions that investors should be asking about active asset management, too.

There’s an enormous body of work developed in the sabermetric community to answer the Good Job question, but here I want to focus on one specific thread — the idea of Wins Above Replacement (WAR). It’s an approach largely credited to Keith Woolner (he calls it Value Over Replacement Player, or VORP), although as with all great concepts there are plenty of parents and plenty of variations on this theme.

Here’s what WAR seeks to measure: if you were replaced with an average player for your specific position, how many fewer games would your team win?

This is a perfect application of the Good Dog’s definition of a Good Job, all in convenient algorithm form!

  1. You know what your job is. We compare shortstops to shortstops, left fielders to left fielders, relief pitchers to relief pitchers. We take into account all aspects of the job, including defense.
  2. The job is in service to the pack. We measure players in terms of how they contribute to winning games for the team. We care about individual statistics only as they relate to team outcomes, not as ends in themselves.
  3. You do the job better than the average dog. You and your major league peers are, by definition, above average. We have the performance data for easily available replacement players (minor league call-ups, mostly), and we’re going to use that as your performance benchmark.

WAR is the Good Job algorithm for baseball. Today, WAR and its variants are the foundation for almost every economic decision that general managers make, from drafts to trades to contracts, in how they structure their team. Not just in baseball, but in every professional team sport.

So what’s the equivalent of WAR for investing?

Well, there’s no snappy acronym in investing, so I’m going to make one up.

Let’s call it PAR — Performance Above Replacement.

In WAR we want to compare the offensive and defensive stats of a professional position player, like a left fielder, to a readily available replacement position player, like a AAA call-up.

In PAR we want to compare the offensive and defensive stats of a professional active manager, like a long/short equity hedge fund manager, to a readily available replacement manager, like an ETF.

What do I mean by offensive and defensive stats? I mean making a distinction between the investment manager’s performance when the market is up and when the market is down. Makes sense, right? There are bull market managers and there are bear market managers and there’s a lot of muddy area in-between. Let’s measure how active managers perform across this crucial dimension for your portfolio so that we don’t miss some skill that might otherwise get lost in the shuffle. This is particularly important for long/short equity and global macro investors because they’re constantly changing their gross and net exposures, and it is the driving force behind the most commonly uttered phrase of active managers trying to explain how they do a Good Job: “We capture x% of the upside in our market but only y% of the downside!” where, of course, x is greater than y. If you haven’t heard (or used) that line 5 bazillion times in your investing career, then … lucky you. In more technical terms (and I’m sorry to do this, but I promise you there will be a payoff), these active managers are saying: “I am doing a Good Job because my performance demonstrates convexity.”

The concept of convexity is at the heart of Performance Above Replacement.

Convexity? Woof … that’s a ten-dollar word if there ever was one.

Let’s say you’ve got an area of your portfolio — call it your “tactical overlay” portion of the portfolio — where you’d like to give active management a shot. You’ve identified an active manager who runs a long/short global macro fund, you’ve decided that this is potentially a “real” diversifying strategy, and now you want to look at the manager’s PAR. Since this manager plays in the Everything sandbox, you’re going to use a global 60/40 investable index (or better yet a global risk parity strategy … yes, I went there) as the “replacement player”, and you’re going to separate out how the manager performs in up markets versus down markets, using the S&P 500 for that distinction because that’s your benchmark.

Here are some stylized absolute return profiles on the left, and the corresponding relative return profile on the right. I’m simplifying things here by drawing straight lines instead of what would be a smattering of point observations (monthly performance numbers, for example), but you can use a linear regression to create the lines. Actually you’re running two linear regressions, one for the manager’s offensive stats (performance when the S&P 500 is up, in green) and one for the manager’s defensive stats (performance when the S&P 500 is down, in red). The blue line is the performance of the replacement strategy (a global 60/40 or risk parity fund). Both funds cross the y-axis slightly below zero (more so for the active manager) to reflect the management fees and expenses associated with the funds.

When you “normalize” the active manager’s performance versus the replacement strategy and the S&P 500, which is what the right-hand graph is doing, you see that this manager nicely outperforms the replacement strategy in difficult markets without underperforming nearly so much when markets are rocking, creating a shallow V-shape or upward bend to the performance line. THIS is convexity.

This manager clearly has positive PAR, meaning that she improves the performance of your portfolio versus what you would have done with a passive replacement strategy, once you take into account both offensive and defensive stats. This manager is like a talented defensive catcher (i.e., a position where it’s important to play good defense) who is a so-so offensive player. That’s a classic player type, and there are plenty of teams who would find a spot on their roster for that.

There are dozens of different tools and well-known performance analytic statistics (Sortino ratio, Jensen’s alpha, upside/downside capture) that will do some variant of this PAR calculation for you, and they’re all designed to capture different aspects of convexity. This sort of exercise is the mother’s milk of consulting gigs, and every consultant in the world would look at this data and tell you that this manager is doing a Good Job.

Pretty exciting, right? Here’s a methodology that clearly works in professional sports and can be directly brought over to professional investing. It’s empirically driven and mathematically sound.

But it doesn’t work.

Or at least it doesn’t work anymore. Like so many other aspects of our investing lives, these mathematically sound and empirically driven efforts to answer the Good Job question for active management have collapsed under the chaotic gravitational pull of The Three-Body Problem.

In exactly the same way that Quality has been absolutely useless as an investment factor for the past eight and a half years, so have our traditional measurements of active manager skill.

The orange line in the chart below is the S&P 500 Index from 1998 to today. The white line and blue-shaded area is the HFRX Global Hedge Fund Index divided by the S&P 500 Index. It represents the relative underperformance or outperformance of hedge funds versus the S&P 500, and today we are at all-time underperformance lows. There is no convexity here! At least not in the aggregate. It skipped town in March 2009, just as the Central Bank Brigade rode in to save the day.

Managers who used to “capture” more upside than downside don’t. Managers who used to demonstrate convexity in their results don’t. They still have lots of stories to tell you about how they manage gross and net exposure, lots of stories to tell you about volatility and risk management, and lots of stories to tell you about thematic opportunities. Most still express a great deal of pride in their investment process.

I’m not saying that these “proprietary processes” will never work again. I’m not saying that they’re not working now. I’m saying that if they’re working, they’re working very very faintly. So faintly that you have to believe in the story to stay the course, because it’s sure not in the aggregate results. I’m saying that the processes and the skills and the performance convexity of professional active investors are swamped by the gravitational pull of $20 TRILLION of central bank balance sheets, as are the traditional tools we’ve used to measure all that. Because that’s the point of the Three-Body Problem – any algorithmic understanding of the system will fail to predict what’s next.

So what’s to be done? Do we just give up trying to answer the Good Job question? If our evaluative tools for active managers are non-predictive, do we just throw ourselves onto the waves of the S&P 500 and hope for the best? Because that’s what a lot of investors are doing, including giant pension funds who should know better, even though doing so is an active management decision of the first order!

Here’s the thing. Yes, It’s more difficult than ever to answer the Good Job question regarding active investment management. It’s also never been more important.

Because while I have no way to predict what’s next in the Three-Body System, I can tell you with absolute certainty that there IS a next, and it will NOT look like now.

Because you ARE the active manager when you select this passively managed fund over that passively managed fund, and you are not as good of an active manager as you think you are.

As wonderful as it would be for investors to style themselves as baseball general managers, poring over advanced performance statistics to pick this or that great fund manager in some sabermetric nirvana, that’s just not in the cards. We have to find a better way, a way to answer the Good Job question in a Three-Body system. Because we’re not getting away from active management even if we wanted to.

Our answer, I think, is to go back to first principles, to go back to the code of the Good Dog. The answer, I think, is in convexity, but not in the mathematical over-scientificized cartoon of the word.

The answer, I think, is in convexity as a philosophy.

Convexity as a philosophy is about identifying what you are particularly good at, and then executing on THAT. It’s the key to unlocking a much more stable notion of identity — a Good Dog’s notion of identity. Good Dogs know what they’re good at, and I don’t need to calculate a Sortino ratio to know if they’re doing a Good Job.

We can do the same with our evaluation of active managers. We can tell when an active manager is doing a Good Job. We can see it in her demeanor, we can see it in her temperament, we can see it in her bravery, both personally and professionally. Every Good Dog is a Brave Dog. It’s the same with investment managers. We can see it in her humility — the virtuous opposite of sinful pride. We can see it in her sense of shame when a behavior is not up to snuff. Not identity, behavior. There’s no shame in identity. Ever.

There’s a sine qua non for adopting convexity as a philosophy in evaluating active managers, and it’s as simple as it is difficult: courage, both personally and professionally. We’ve got to be Brave Dogs, too.

To be clear, the behavioral attributes associated with a Good Dog’s notion of a Good Job are a necessary condition for approving an active manager, not a sufficient condition. Sam the Sheltie does a Good Job, too, but I wouldn’t exactly recommend an accomplished squirrel herder as a must-have addition to your farm. Even Maggie the German Shepherd, who does a Good Job of protecting the farm and is a player everyone would want on their team, has “regimes” where her above-replacement performance vanishes. I’ll put it this way … she apparently dislikes chickens almost as much as I do, such that if you’re a fox and you want to chow down on a free range hen or two, picnic-style in the middle of a grassy field while Maggie sits there and watches you eat … well, come on over. And that gets me to the second sine qua non of adopting convexity as a philosophy in our manager selection — we must have the process and the fortitude to scale our active risk allocations up and down based on what is working, including the ability to take risk completely away from our managers. Maggie is a VERY Good Dog. But when the chickens are loose her risk allocation here at the farm goes to zero. We find protection somewhere else.

Convexity as a philosophy is also at the heart of how we improve ourselves and our children as citizens.

Always be yourself. Unless you can be Batman. Then always be Batman.

It’s maybe the funniest movie line I know. Why is this funny? Because we have made a political and social fetish out of identity, out of the New Commandment to ALWAYS BE YOURSELF. Unless you can be Batman.

At the same time, we’ve attached pride and shame to identity, rather than to behavior where they belong, training ourselves and our children to be absurdly self-assured and prideful, and yet existentially ashamed all at the same time. ALWAYS BE YOURSELF is the most powerful story we tell ourselves. And the most dangerous if attached to pride and shame wrongly understood.

We can tell ourselves a new story. A story, dear Brutus, where the fault is not in our stars, but in ourselves. As is the achievement. As is the honor.

Find your pack. Here and here and here are some ideas on how to do that. And then do a Good Job with your service to the pack, no matter how big, no matter how small. You’ll figure it out.

Every dog needs a job to make sense of its place in the world. So does every human.

PDF Download (Paid Subscription Required): http://www.epsilontheory.com/download/15734/


Year In Review

We’ve had a heckuva busy year at Epsilon Theory, so to ring out 2017 I thought it might be helpful to distribute a master list of our publications over the past 12 months. We’re long essay writers trying to make our way in a TLDR world, so even the most avid follower may well need a map!

It’s also a good opportunity to give thanks where thanks are due.

First, a heartfelt thank you to my partners at Salient for contributing a ton of resources to make Epsilon Theory happen, never once asking me to sell product, and allowing me the leeway to speak my mind with a strong voice that would make a less courageous firm blanch. Epsilon Theory isn’t charity, and it’s the smart move for a firm playing the long game, but no less rare for all that.

Second, an equally heartfelt thank you to the hundreds of thousands of readers who have contributed their most precious resource – their time and attention – to the Epsilon Theory effort. We live in a world that is simultaneously shattered and connected, where we are relentlessly encouraged to mistrust our fellow citizens IRL but to engage with complete strangers on social media. It’s an atomized and polarized existence, which works really well for the Nudging State and the Nudging Oligarchy, less well for everyone else. The lasting impact of Epsilon Theory won’t be in what we publish, but in how we’re able to bring together truth-seekers of all stripes and persuasions, because it’s your engagement with the ideas presented here that will change the world. I know that sounds corny, but it’s happening.

Now on to the 2017 publishing map.

Our big initiative for this year was to publish two coherent sets of long-form notes, one by yours truly and one by my partner Rusty Guinn.

My series of essays is called Notes From the Field. As many long-time readers know, I’m originally from Alabama but now live out in the wilds of Fairfield County, Connecticut, on a “farm” of 44 acres. I put that word in quotations because although we have horses and sheep and goats and chickens and bees, my grandfather – who owned a pre-electrification, pre-refrigeration, pre-pasteurization dairy farm in the 1930s – would surely enjoy a good belly laugh at my calling this a farm. Still, I’ve learned a few things over the years from the farm and its animals, and they’ve helped me to become a better investor.

  1. Notes From the Field: The eponymous note has two essays: “Fingernail Clean”, introducing the concept of the Industrially Necessary Egg – something we take for granted as proper and “natural” when it’s anything but, and “Structure is a Cruel Master”, introducing the genius of both humans and bees – our ability to build complex societies with simple algorithms.
  2. The Goldfinch in Winter: What can a bird teach us about value investing? To everything there is a season.
  3. Horsepower: The horse and horse collar revolutionized European agriculture in the 10th and 11th centuries, a revolution that lives on in words like “horsepower” and changed the course of human civilization. Today we are struggling with a productivity devolution, not revolution, and there is nothing more important for our investments and our politics and our future than understanding its causes and remedies.
  4. The Arborist: We are overrun with Oriental Bittersweet, privet, and kudzu — or as I like to call them, monetary policy, the regulatory state, and fiat news — invasive species that crowd out the small-l liberal virtues of free markets and free elections. What to do about it? Well, that’s citizenship, and I’ve got some ideas.
  5. Always Go To the Funeral: Going to the funeral is part of the personal obligation that we have to others, obligation that doesn’t fit neatly or at all into our bizarro world of crystalized self-interest, where scale and mass distribution are ends in themselves, where the supercilious State knows what’s best for you and your family, where communication policy and fiat news shout down authenticity, where rapacious, know-nothing narcissism is celebrated as leadership even as civility, expertise, and service are mocked as cuckery. Going to the funeral is at the heart of playing the meta-game – the game behind the game – of social systems like markets and elections, and it’s something we all need to understand so that we’re not played for fools.
  6. Sheep Logic: We think we are wolves, living by the logic of the pack. In truth we are sheep, living by the logic of the flock. In both markets and politics, our human intelligences are being trained to be sheep intelligences. Why? Because that’s how you transform capital markets into a political utility, which is just about the greatest gift status quo political institutions can imagine.
  7. Clever Hans: You don’t break a wild horse by crushing its spirit. You nudge it into willingly surrendering its autonomy. Because once you’re trained to welcome the saddle, you’re going to take the bit. We are Clever Hans, dutifully hanging on every word or signal from the Nudging Fed and the Nudging Street as we stomp out our investment behavior.
  8. Pecking Order: The pecking order is a social system designed to preserve economic inequality: inequality of food for chickens, inequality of wealth for humans. We are trained and told by Team Elite that the pecking order is not a real and brutal thing in the human species, but this is a lie. It is an intentional lie, formed by two powerful Narratives: trickle-down monetary policy and massive consumer debt financing.

The Three-Body Problem: What if I told you that the dominant strategies for human investing are, without exception, algorithms and derivatives? I don’t mean computer-driven investing, I mean good old-fashioned human investing … stock-picking and the like. And what if I told you that these algorithms and derivatives might all be broken today?

Rusty’s series of essays, Things that Matter (and Things that Don’t), connects to mine with his just published The Three-Body Portfolio. It’s a wonderful piece on its own (I can’t believe I didn’t think of the Soylent Green reference – Epsilon is people!) and is a great segue to his 2017 serial opus. In chronological order:

  1. With A Man Must Have a Code, Rusty begins the conversation about why we think that all investors ought to have a consistent way of approaching their major investment decisions.
  2. In I am Spartacus, Rusty writes that the passive-active debate doesn’t matter, and that the premise itself is fraudulent.
  3. In What a Good-Looking Question, Rusty writes that trying to pick stocks doesn’t matter, and is largely a waste of time for the majority of investors.
  4. In Break the Wheel, Rusty argues that fund picking doesn’t matter either, and he takes on the cyclical, mean-reverting patterns by which we evaluate fund managers.
  5. In And they Did Live by Watchfires, Rusty highlights how whatever skill we think we have in timing and trading (which is probably none) doesn’t matter anyway.
  6. In Chili P is My Signature, Rusty writes that the typical half-hearted tilts, even to legitimate factors like value and momentum, don’t matter either.
  7. In Whom Fortune Favors (Part 2 here), Rusty writes that quantity of risk matters more than anything else (and that most investors probably aren’t taking enough).
  8. In You Still Have Made a Choice, Rusty writes that maximizing the benefits of diversification matters more than the vast majority of views we may have on one market over another.
  9. In The Myth of Market In-Itself (Part 2 here), Rusty writes that investor behavior matters, and he spends a lot of electrons on the idea that returns are always a reflection of human behavior and emotion.
  10. In Wall Street’s Merry Pranks, Rusty acknowledges that costs matter, but he emphasizes that trading costs, taxes and indirect costs from bad buy/sell behaviors nearly always matter more than the far more frequently maligned advisory and fund management expenses.

But wait, there’s more!

You’ve got two more essays from Rusty:

  1. Before and After the Storm
  2. Gandalf, GZA and Granovetter

You’ve got 10 more essays from me:

  1. Harvey Weinstein and the Common Knowledge Game
  2. Mailbag! Fall 2017 Edition
  3. Mailbag! Midsummer 2017 Edition
  4. Gradually and Then Suddenly
  5. Tell My Horse
  6. Westworld
  7. The Horse in Motion
  8. Mailbag! Life in Trumpland
  9. The Evolution of Competition
  10. Fiat Money, Fiat News

Oh yeah, and you’ve got eleven 2017 podcasts here.

So there’s your 2017 Epsilon Theory map. 2018 will be even better.

The Three-Body Problem

As much as I dislike the chickens on our farm, I love my bees. Do they sting? Of course they sting. The swarm is a wild animal. But after a few painful years I’m no longer a ham-handed goofball with my hives, and a morning spent in sync with this amazing animal is never a bad morning. Not only are bees low maintenance, not only do they pay a wonderful rent, but they demonstrate a genius and an optimism — there’s just no other word for it — that makes me feel more creative and alive.

The Connecticut winters are tough, though. I do what I can to support the bees, which is mostly just building a wind break with bales of straw, making sure that the hive stays ventilated enough to prevent water vapor condensation, and preventing mice from taking up residence. That and avoiding original sins like poor hive placement or collecting too much rent. But ultimately it’s a battle between the animal and Mother Nature. It’s up to them to survive. Or not.

Honeybees don’t hibernate (bumblebees do, but hive colony bees don’t), and they can’t fly south for the winter. To survive a Northern winter, bees change the composition of the swarm by shrinking the overall population, caulking the hive, getting rid of the deadweight males (i.e., ALL of the males), and laying just enough eggs to preserve a minimal survivable population through the winter and into spring. They cluster together in the center of the hive, keeping the queen in the center, shivering their wings to create kinetic energy, occasionally sending out suicide squads to retrieve honey stores from the outer combs. They lower their metabolism by creating a cloud of carbon dioxide in the hive. Yes, a carbon dioxide cloud.

All of this preparation takes time. To survive winter, the swarm starts to change its behaviors — from brood patterns to pollen collection to comb creation — not when the weather starts getting cold, but in the middle of summer when the dog days of August are still in front of us. And not just on some random date, but on a completely predictable day.

In 2018 my bees will begin to prepare for winter on Friday, June 22nd.

Why? Because bees can measure the angle of the sun’s rays. They can remember this from one day to the next. When today’s midday sun is ever so slightly lower in the sky than yesterday’s midday sun, a bee will know it. And the entire colony will begin to change.

Bees recognize the freakin’ summer solstice with as much accuracy as any human civilization ever did.

See? Genius. But we’re just getting started.

When bees act on their awareness of the summer solstice, they are trading a derivative. And they expertly manage the basis risk of that trade.

Huh? Time out, Ben. What are you talking about?

A derivative, in the broadest sense of the word, is something that’s related to something else you care about (the “underlying”), but for whatever reason you choose to interact with the derivative-something rather than the underlying-something. For humans, you might care about the stock price of company XYZ, so that’s the underlying, but you think something momentous is going to happen to the company three months from now, so you interact with a derivative on the stock, in this case a three-month option contract. For bees, the thing they truly care about is how cold it gets, so from their perspective the temperature is the underlying and the sunlight angles are the derivative thing that they analyze and interact with. In truth, of course, it’s the tilt of the Earth’s axis and the resultant sunlight angles that cause seasonality and temperature changes, so a curmudgeonly reader might accurately say that actually, it’s the temperature that’s the derivative here, but I trust we’re all open-minded enough to take a bee’s eye view of the world for the duration of this note.

Why do bees take their behavioral cues from sunlight angles rather than temperature change directly? Because the algorithm for predicting seasonality:

IF (maximum incident angle of sunlight today is less than the maximum incident angle of sunlight yesterday)

THEN (prepare for winter)

is enormously simpler, more predictive, more timely, and less volatile than any sort of temperature time-series analysis, or at least any temperature time-series analysis available to bees and pre-weather satellite humans. The genius (and fatal flaw) of bees and humans is their ability to create complex social systems on the basis of simple algorithms like this. Modern computing systems of the Big Data sort have a very different type of genius.

Hold that thought.

But first let’s make sure we understand what basis risk means, and why it’s The Most Important Thing to understand when you’re dealing with derivatives. “Basis” is the relationship between the derivative and the underlying, and so basis risk is how bad things could get if the relationship between derivative and underlying isn’t as tight as you thought it was. For bees, basis risk takes the form of cold weather coming sooner or later than normal. Shrinking the colony like clockwork based on the summer solstice works great if the first big freeze comes in November, not so well if you get a big snow in mid-October.

The key to managing basis risk is to keep your risk antennae (literally antennae when it comes to bees) focused on how well the derivative thing is tracking with the underlying thing. You need to watch the correlation. So to manage their basis risk, bees are also sensitive to temperature (the underlying) and all of the other derivative things related to changing temperature, like flower bloom patterns or prevailing winds. Nothing will totally override the summer solstice trade (even tropical bees make some small colony adjustments based on seasonality), but bees are adaptive investors, able to accelerate their winter preparation if cold weather comes early or delay it if cold weather comes late. Efficient management of basis risk is a balancing act between sticking with the original trade and adapting your behavior to changing correlations (you don’t want to mistake an Indian Summer for spring!), but that’s the beauty of evolution — billions of bee colonies over millions of years have lived and died and reproduced to naturally select the combination of hard-wired nervous system algorithms that allows honeybee species to thrive across a wide range of ecosystems and a wide range of seasonal weather variations.

But it’s only a range. Bees can’t live in as wide a range of ecosystems and weather variations as, say, ants. I doubt there’s a bee colony on Earth that can survive six months straight of sub-50 degree weather. If you’re a bee colony and you’ve moved that far north and that’s the magnitude of your downside basis risk, it really doesn’t matter how amazing you are in your solar declination calculations … you’re not going to make it. Maybe you get lucky for a couple of years, but if it’s possible that you could have four or five months of harshly cold weather, then sooner or later that severe basis risk catches up with you. This is a basis risk that you can’t insure against, that you can’t hedge against with extra preparation or precaution. It’s an unmanageable basis risk. For most of North America, though, even pretty far up into Canada, cold weather is a manageable basis risk, particularly if you’ve got a beekeeper able to lend a helping hand. Sometimes the bees will get a bad roll of the weather dice and you’ll lose a hive to basis risk, but it doesn’t threaten the species.

Species risk comes into play when you get a major climactic event that lasts for a long time in terms of a colony’s lifespan but not long at all in terms of evolution, genetic mutation, and natural selection. Like, say, what if spring no longer followed winter? What if it snowed in August and flowers bloomed in January? What if winter disappeared for a decade? What if it lasted that long? What if your weather basis risk was unknowable, as in Game of Thrones? Even a short Westerosi winter of a couple of years would kill every bee colony on the continent, which is why I don’t think I’ve ever seen a bee hive on Game of Thrones. [Hmm … I’ve just been informed by Grand Maester Guinn that “one of the Baratheon vassal houses of the Reach is House Beesbury, with a family seat of Honeyholt and a family motto of Beware Our Sting.” Sigh. You see what I have to put up with? Okay, we’ll stipulate that Dornish latitudes are safe. But The North is no place for bees when winter comes!]

This is basis uncertainty, where you’re not even sure that any basis exists at all, as opposed to mere basis risk. Basis uncertainty is an unknowable basis risk, which is much more damaging to species development than the occasional bout of severe basis risk.

[Long parenthetical: understanding the distinction between risk and uncertainty is crucial in every aspect of life. A risky decision is when you have a pretty good sense of the odds and the pay-offs. It lends itself to statistical analysis and econometrics, particularly if it’s a decision you will have the opportunity to make multiple times. An uncertain decision is when you don’t have a good sense of odds and pay-offs. Here, statistical analysis may very well kill you, particularly if you’re not going to get many cracks at the game, or if you don’t know how many times you’ll get to make a choice. You need game theory to make sense of decisions made under uncertainty.]

Basis uncertainty is the core problem facing every investor today.

It’s not just that we endure large basis risks here in the Hollow Market, unmanageable for many. It’s not just that all of our old signposts and moorings for navigating markets aren’t working very well. It’s not just difficult to identify predictive/derivative patterns in today’s markets. There is a non-trivial chance that structural changes in our social worlds of politics and markets have made it impossible to identify predictive/derivative patterns. THIS is basis uncertainty, and it’s as problematic for humans facing markets that don’t make sense as it is for bees facing weather patterns that don’t make sense.

Well, that’s just crazy talk, Ben. What do you mean that it might be impossible to identify predictive/derivative patterns? What do you mean that basis might not exist at all? Of course there’s a pattern to markets and everything else. Of course spring follows winter.

Nope. This is the Three-Body Problem.

Or rather, the Three-Body Problem is a famous example of a system which has no derivative pattern with any predictive power, no applicable algorithm that a human (or a bee) could discover to adapt successfully and turn basis uncertainty into basis risk. In the lingo, there is no “general closed-form solution” to the Three-Body Problem. (It’s also the title of the best science fiction book I’ve read in the past 20 years, by Cixin Liu. Truly a masterpiece. Life and perspective-changing, in fact, both in its depiction of China and its depiction of the game theory of civilization.)

What is the “problem”? Imagine three massive objects in space … stars, planets, something like that. They’re in the same system, meaning that they can’t entirely escape each other’s gravitational pull. You know the position, mass, speed, and direction of travel for each of the objects. You know how gravity works, so you know precisely how each object is acting on the other two objects. Now predict for me, using a formula, where the objects will be at some point in the future.

Answer: you can’t. In 1887, Henri Poincaré proved that the motion of the three objects, with the exception of a few special starting cases, is non-repeating. This is a chaotic system, meaning that the historical pattern of object positions has ZERO predictive power in figuring out where these objects will be in the future. There is no algorithm that a human can possibly discover to solve this problem. It does not exist.

To visualize the Three-Body Problem, here’s a simulation of the orbits of green, blue, and red objects with random starting conditions, each exerting a gravitational pull on the others. What Poincaré proved is that there is no formula where you can plug in the initial information and get the right answer for where any of the objects will be at any future point in time. No human can predict the future of this system.

But a computer can. Not by using an algorithm, which is how biological brains — human and bee alike — evolved to make sense of the world, but by brute force calculations. Remember, you know everything about these three objects … none of the physics here is a mystery. If you can do the calculation quickly enough, you can compute where all three objects will be one second from now. And one second from then. And one second from then. And so on and so on. With enough processing power (and this can require a LOT of processing power) you can calculate where the three objects will be 100 years from now, even though it is impossible to solve for this outcome.

It’s a hard concept to wrap your head around, this difference between calculating the future and predicting the future, but it will change the way you see the world. And your place in it.  

Now here’s an observation that I can’t emphasize strongly enough, although I’ll try:

THIS IS NOT HOW WE USE COMPUTERS IN OUR INVESTING STRATEGIES TODAY

The way that computers can calculate an answer to the Three-Body Problem is straightforward — they can be programmed with the physics rules for how one object influences another object, so they can simulate where each object will go next. There is ZERO examination of where the objects have been in the past. This is entirely forward looking.

The way that computers can NOT calculate an answer to the Three-Body Problem is by examining the historical data of where the objects have been. In a chaotic system, it doesn’t matter how hard or how fast or how deeply you look at the historical data. There is NO predictive pattern, NO secret algorithm hiding in the data. And yet this is exactly what we all have our computers doing … examining historical data to look for patterns that will give us the magic algorithm for predicting what’s next! The only thing that the past gives you in a chaotic system is inertia, which can look like a pattern or an algorithm for some period of time, depending on how all the objects are aligned. But it’s a mirage. It will not last. Examining the past of a chaotic system can give you lots of little answers, like sparks off a bonfire, none lasting more than a few seconds. And certainly if you’re efficient with your inertia-identifying spark-capturing effort, you can make some money using computers this way. But this examination of the past through naïve induction will never give you The Answer. Because The Answer does not exist in the past. The Answer — which is another word for algorithm, which is another word for “general closed-end solution” — doesn’t exist at all in a chaotic Three-Body System.

But we can approximate The Answer. We can calculate the future in small computational chunks even if we can’t predict the future in one big algorithmic swoop, but only if we can program the computer with the “physics” of how “gravity” works in social systems like markets. What’s our financial world equivalent of a theory of gravity? I think it’s a theory of narrative. This, to me, is a more interesting research program than identifying small inertias or capturing brief sparks. But it’s not where our computing resources are being allocated, because there’s no money in it. Yet.

Exploring a theory of narrative, what I’ve called the Narrative Machine, is basic research. Like all basic research, it’s not immediately remunerative and thus is difficult to fund. But that’s not the biggest obstacle. No, the biggest obstacle to basic research in computational finance is that humans are hard-wired to look for algorithms and have a really hard time imagining that it’s even possible to pursue a non-anthropomorphic (how about that for a $10 word) research design that doesn’t pore through historical data looking for predictive algorithms at every turn. We can’t help ourselves!

What if I told you that algorithms and derivatives are as much at the heart of how humans prepare for their financial future as they are for bees preparing for their seasonal future? What if I told you that the dominant strategies for human discretionary investing are, without exception, algorithms and derivatives? And what if I told you that these algorithms and derivatives were perhaps “evolved” under a “benign” configuration of the Three-Body Problem that not only might never repeat, but in fact is certain to never repeat because it is a chaotic system?

I’ll give you two examples of influential investment algorithms/derivatives. There are many more.

GOOD COMPANIES => GOOD STOCKS

GOOD COUNTRIES => GOOD GOVERNMENT BONDS

These are the central tenets of stock-picking and sovereign bond-picking, respectively. In both cases, goodness (like beauty) is in the eye of the beholder, so I’m not saying that there is some single standard for what makes a “good” company or what makes a “good” set of macroeconomic policies. What I’m saying is that everyone reading this note (including me!) believes that there is a direct relationship between the quality of a company or an economy (however you define quality) and the future price of whatever stocks or bonds are connected to that company or economy. What I’m saying is that everyone reading this note believes that tracking the measurable quality of a company or an economy (the derivative) according to some standardized and repeatable process (the algorithm) will, over time, have a predictive correlation with the future price of the related stock and bond securities (the underlying).

What stocks do we want to own? Why, the stocks of high quality companies, of course … companies with stellar management teams, fortress balance sheets, and wonderful products or services that everyone wants to buy. Ditto for government bonds and currencies and broad market indices and the like. Maybe it will take some time for this faith in Quality to pay off, but we all believe that it WILL pay off. It’s only natural, right? As natural as spring following winter. As natural as flowers blooming in May and snow falling in December. Maybe the flowers will bloom a few weeks late and maybe the snows will fall a few weeks early, but that’s just basis risk, and we can manage for that.

But what if spring doesn’t follow winter anymore?

Look, I’m not asking us to abandon our faith in Quality. One of the key corrolaries of the Three-Body Problem is that we don’t have to reject our belief that Objects 1 and 2 exist. We don’t have to deny our faith that the Quality-of-Companies is an actual thing and that it has a big gravitational pull on the price of stocks. We don’t have to deny our faith that the Quality-of-Governments is an actual thing and that it has a big gravitational pull on the price of government bonds.

What we have to accept is that there is an Object 3 that has moved into a position such that its gravity absolutely swamps the impact of Objects 1 and 2. This Object 3, of course, is extraordinary monetary policy, specifically the purchase of $20 TRILLION worth of financial assets by the Big 4 central banks — the Fed, the ECB, the BOJ, and the PBOC.

$20 trillion is a lot of mass. $20 trillion is a lot of gravity.

Here’s the impact of all that gravity on the Quality-of-Companies derivative investment strategy.

The green line below is the S&P 500 index. The white line below is a Quality Index sponsored by Deutsche Bank. They look at 1,000 global large cap companies and evaluate them for return on equity, return on invested capital, and accounting accruals … quantifiable proxies for the most common ways that investors think about quality. Because the goal is to isolate the Quality factor, the index is long in equal amounts the top 20% of measured  companies and short the bottom 20% (so market neutral), and has equal amounts invested long and short in the component sectors of the market (so sector neutral). The chart begins on March 9, 2009, when the Fed launched its first QE program.

Over the past eight and a half years, Quality has been absolutely useless as an investment derivative. You’ve made a grand total of not quite 3% on your investment, while the S&P 500 is up almost 300%.

This is not a typo.

Have the Quality stocks in your portfolio gone up over the past eight and a half years? Sure, but it’s not because of the Quality-ness of the companies. It’s because ALL stocks have gone up ever since Object 3, the balance sheets of central banks, started exerting its massive gravity on everything BUT Quality. That’s not an accident, by the way. Central banks don’t care about rewarding “good” companies. In fact, if they care about anything on this dimension, they care about keeping “bad” companies from going under.

This is what it looks like when spring does not follow winter.

And here’s the impact of all that gravity on the Quality-of-Countries derivative investment strategy.

The gold line below is the spread (difference) between Portugal’s 10-year bond yield and the U.S. 10-year bond yield, and the blue line is the spread between Italy’s 10-year note yield and the U.S. equivalent. In “normal” times, a country with a weaker set of macroeconomic characteristics (high levels of national debt, say, or maybe low productivity) will have to offer investors a higher rate of interest to borrow their money than a country with a stronger set of macroeconomic characteristics. So in the summer of 2012, when Portugal and Italy were both looking like deadbeat countries, they had to pay investors a much higher rate of interest than the U.S. did to attract the investment … about 9% more (this is per year, mind you) for Portugal and 4% more for Italy. Those are enormous spreads in the world of sovereign debt!

This chart begins in the summer of 2012, when the ECB announced its intentions to prop up the European sovereign debt market directly. Since that announcement — even though both Portugal and Italy have higher debt-to-GDP ratios today than in 2012 — the spread versus U.S. interest rates has done nothing but decline. Driven by the commitment of the ECB to “do whatever it takes” and to be not only a last-resort buyer but also a first-in-line buyer of Portuguese and Italian debt, it now costs LESS for these countries to borrow money for 10 years than the U.S.

This is nuts. It’s an understandable nuts when you consider that the German 10-year bond yield is currently about 30 basis points, and was actually negative (meaning that you had to pay the German government for the privilege of lending them money for the next 10 years) for about six months in 2016. Meaning that at least with Italian and Portuguese debt you’re being paid something (a little less than 2% per year). It’s an understandable nuts when you consider that the Swiss 10-year bond still sports a negative interest rate and has been negative for the past two and a half years. There’s about $10 trillion worth of negative yielding sovereign bonds out there today, something that is IMPOSSIBLE under a [good country => good bond] derivative algorithm. No country is that good! But it’s entirely possible under the immense gravitational force of massive central bank asset purchases.

Here’s the kicker. Below is the spread between Greek 10-year sovereign bonds and U.S. 10-year notes. In 2012 you were paid 24% more to lend money to Greece. Per year! Today you are paid less than 2% more to lend money to Greece rather than the United States. For ten years. To Greece.

Again, I’m not saying that the Quality derivative doesn’t exist as a real thing or that it isn’t an important factor in the history of successful stock-picking or bond-picking. What I’m saying is that the Quality derivative hasn’t mattered for eight and a half years with stocks and five years with sovereign debt. What I’m saying is that it might not matter for another eighty years. Or it might matter again in eight months. A Three-Body System is a chaotic system. As the boilerplate says, past performance is not a guarantee of future results. In fact, the only thing I can promise you is that past performance will NEVER give you a predictive algorithm for future results in a chaotic system.

This is basis uncertainty. This is the biggest concern that every investor should have, that the signals (derivatives) and processes (algorithms) that we ALL use to make sense of the investing world are no longer connected to security prices.

… Okay, Ben, you’ve exhausted me. It’s a weird and strange way of looking at the world, but let’s go with it for a minute. What’s the pay-off here? What do we DO in a chaotic system? What does that even mean, to say that we are investors in a chaotic system?

Four suggestions.

First, I think we should adopt a philosophy of what I’ve called profound agnosticism when it comes to investing, where we don’t just embrace the notion that no one has a crystal ball in this system, but we actually get kinda annoyed with those who insist they do. I think that risk balancing strategies make a ton of sense in a chaotic system, so that we think first about budgeting our risk agnostically across geographies and asset classes and sectors, and secondarily think about budgeting our dollars.

Second, and relatedly, I think we should adopt a classic game theory strategy for dealing with uncertain systems — minimax regret. The idea is simple, but the implications profound: instead of seeking to maximize returns, we seek to minimize our maximum regret. Keep in mind that our maximum regret may not be ruinous loss! I know plenty of people whose maximum regret is not keeping up with the Joneses. In fact, from a business model perspective, that’s more common than not. Or if you’ve bought into Bitcoin north of $15,000 per coin, I think you know what I’m talking about, too. The point being that we need to be painfully honest with ourselves about our sources of regret and target our investments accordingly. If we can be this honest with ourselves, it’s a VERY powerful strategy.

Third, I think we should reconsider our approach to computer-directed investment strategies. Using computers in an anthropomorphic way, where we treat them like a smarter, faster human, set loose in a vast field of historical data to search for patterns and algorithms … it’s a snipe hunt. Or at least I think we’ve squeezed just about all the juice out of this inductive orange that we’re likely to get. With the massive processing power at our fingertips today, not to mention the orders-of-magnitude-greater processing power that quantum computing will bring to bear in the future, there’s much bigger game afoot with computational approaches that take a more deductive, forward-looking strategy.

Fourth, and perhaps most importantly, I think we need to accept that we’re never going to fully understand the reality of a chaotic system, but that it’s never been more important to try. The brains of both bees and humans are hard-wired for algorithms. Both species see patterns even when patterns don’t exist, and both species tend to do poorly in environments where derivative signals are plagued by basis uncertainty rather than mere basis risk. Every bee in the world will follow its hard-wired algorithms even unto death. And most humans will, too. But humans have the capacity to think beyond their biological and cultural programming … if they work at it.

Where do we lose good people? When they convince themselves that they’ve found The Answer — either in the form of a charismatic person or, more dangerously still, a charismatic idea — in a chaotic system where no Answer exists. A chaotic system like markets, yes, but also a chaotic system like politics.

The Answer is, by nature, totalitarian. Why? Because it’s a general closed-form solution. That’s the technical definition of The Answer, and that’s the practical definition of totalitarian thought. We’re hard-wired to want the all-encompassing algorithm, which is why it’s so difficult to resist. But if we care about liberty. If we care about justice. If we care about liberty and justice for all … we have to resist The Answer.

Because we’ve lost enough good people.

As wise as serpents, as harmless as doves …

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Mailbag! Fall 2017 Edition

Back by popular demand, it’s the Epsilon Theory Mailbag!

Always Go To the Funeral” and “The Arborist

Another rifle shot to the crux of the matter.

I would like to think that I, as a loyal reader of The Epsilon Theory, am onto many of the manipulations that you describe. But as I was reading this letter, I realized that I had fallen – lock, stock and barrel – for the powerful manipulation that you describe in connection with the removal of confederate statues. I, like you, really don’t have much psychological or emotional investment in the statues themselves (although I do think they serve as a constant visual reminder of our conflicted history – a good thing, in my opinion). But I am quite psychologically and emotionally invested in the maintenance of civility and order.

The manipulators have done a great job causing me to transfer my investment in civility and order onto these physical statues, thereby putting me in the uncomfortable position of defending something I don’t care that much about to prevent others (who represent things I abhor) from “winning.” But in the process, I now find myself siding with another group that also represents these same things that I abhor. This cognitive dissonance is the source of the increasing anger and frustration that many heretofore stable members of our society are now feeling and, unfortunately, beginning to express outwardly.

While I understand your point about “going to the funeral” of the “Cooperation Game” era of political discourse, I hope that is not a joint funeral with the “civility and order” era of society. I am afraid that might just be the case. I am especially worried about this because those (like the state) who, in the past, acted as a damper on disunion, incivility and disorder now seem to be the drivers.

Thanks again for putting a mirror up for those of us who strive every day to be a bit better (and smarter).

Jeff

It’s so easy to get pulled into these constructed, false “conflicts” … we are truly hard-wired to respond to this stuff. I am constantly catching myself falling into this trap, and I write these notes as a self-help mechanism as much as anything.

I suppose that you read about the vandalism and subsequent removal of the Robert E. Lee statue at Duke Chapel. I am just wondering how long it will take for someone to vandalize the beautiful marble carving of Lee at Lee Chapel on the campus of Washington and Lee in Lexington, VA.

A week ago, somebody wrote to the local paper that the Confederate memorial in Elmwood Cemetery near uptown Charlotte should be removed. Only history buffs and PC activists even know that it exists – few people ever go to the cemetery, because it is just about full. (Charlotte native Randolph Scott is probably the most famous occupant, BTW.)

My father was Southern through and through, gentle, loved and respected. He named me after two of his uncles, who were named after famous Southern leaders. But he never bothered to tell me about his grandfather, who was wounded in Pickett’s charge at Gettysburg and surrendered with Lee at Appomattox Courthouse, or his other grandfather who was killed at Gettysburg. And even more regrettable, he never told us a lot about his experiences in WWII.

All the best. I’ll sign my entire name, just this time.

Houston Lee VanHoy

On the other hand …

Ben – as someone who lived in Charlottesville for a number of years, your logic was peculiarly fraught and tortured this week…intentional or not, your note misses a salient point of last weeks armed riot – yes there is no other word for it – in Charlottesville.

What it was at its core was an intimidating show of force replete with openly carried loaded automatic weapons and rifles let alone pistols/revolvers. This is indisputable and the only question is why? It’s at least about promoting the myth that Confederates were not traitors, and deserve an honored place in our public square. I’m sorry if it makes anyone sad to realize their great grandfathers were traitors and racist, but there can be no justice until there is truth.

It’s not a matter of rolling back history, it’s a matter of presenting history accurately, and Lee and his ilk were prima facie traitors in every sense of the word to the United States and DIRECTLY responsible for hundreds of thousands of deaths. So why is Lee so exulted, and by extension, the Confederacy? It’s because the demonstrators want to perpetuate and glorify the Rebellions myth, and deny that it was all about preserving and promoting slavery – that’s a narrative that can be safely and properly consigned to museums at best, and have no place in our public square, esp. in federal places and local places where the local city/town wants them removed.

These people don’t need any explanation or sympathy from someone as bright as you. If these statues are so trivial and unimportant to the South sense of self, why not just consign them to museums. Fascism precedes Antifa, i.e. it is axiomatic that there is no Antifa without fascism first. Fascism is not a response to Antifa – thats illogical. Anyone with real pride would actively move in this direction to dispel misgivings that the South has not risen above treason, racism and white supremacy. Should be a no brainer…do you see any statues to Benedict Arnold in the South?

If a right leaning local population wanted to someday rename Malcolm X Blvd, and militant armed blacks showed up shouting “death to whitey”, we can have a dialogue of equivalency in this regard. Until then you are way off and justifiably at jeopardy being labeled as enabling of Nazis and white supremacists. Hopefully this was a rare “own goal” and not intentional.

It’s really not all that hard or complicated, and it only contaminates our politics when people make excuses for fascism and racism.

– JD

Aaaaand, there it is: I am “justifiably at jeopardy of being labeled as enabling Nazis and white supremacists” because I did not write a strong enough denunciation of Confederate statues. “Hopefully” this was not an intentional support of Nazis and white supremacists on my part.

I’m reading an amazing book right now, “The Three-Body Problem” by Cixin Liu, translated from the original Chinese by Ken Liu. It’s science fiction, winning the Hugo Award for Best Novel in 2015, and like all great science fiction it’s actually just great fiction, period. Great fiction forces us to see the world differently, and “The Three-Body Problem” — which starts off in 1967 China — has opened my eyes to an understanding of what the Cultural Revolution really was. I won’t spoil it any more than that, except to say that JD would have thrived within the Cultural Revolution.

I have been reminded this week of you saying (I think it was you) that real danger exists when we move from viewing each other as good people with different opinions, to viewing the people on the other side as evil!

If you are a rational person who believes that historic monuments in the South serve a purpose (I remember a family vacation to Stone Mountain where I learned all about the civil war), now you are on the side of the Nazi’s – the damn Nazi’s my Grandfather (whom I am named after) died fighting!!! It seems we are being put into a box where you must choose a side … I believe both the President and fiat news are engaged in a war of propaganda … dangerous times indeed.

LP

We are ALL being played. Including JD.

“and by the way you’re bonkers if you think the Russians altered the 2016 election by one iota.”

Interesting take. Can you explain to me why they – the Russians – would invest so much time and money on something that has absolutely no impact? Also, why do advertising firms exist and why is propaganda a thing?

Jason

No impact? Russian chicanery had a HUGE impact on us, by sowing mistrust and apprehension about our electoral process, even though it had ZERO impact on the outcome. Best money the Russians ever spent.

The circumstances that create competition games can be overcome. As someone attached to the Nixon Administration, the fact that the core of the Republican Party in the House and Senate in the end refused to play those games (Goldwater, Rhoades [sic] and Scott being the emissaries that told him he had to leave) and Gerry Ford kept it from getting out of hand. It is difficult to see that dynamic in the current context. With the demographic Great Sort and the computer “optimization” of gerrymandering, and with apologies to W. B. Yeats, there is precious little center left to do the holding.

– Al

Yeats is getting quite the work-out in reader letters of late, for good reason.

If the centre doesn’t hold, are discussions of Fed Policy ironic, comic or merely prosaic?

Naked Capitalism shut down their already Moderated comments today. Like many places in society, people are losing their minds and civility is breaking down.

Less recognized is that we are beset by fairly organized manipulation and disinfo.

As an exasperated friend put it, “don’t people realize as a nation we are being trolled and all sides are falling for it?”

Parts of the media/gov/corps are doing the dog whistles while the rank and file of the same madly bark and bite.

Yeats poem “The Second Coming” is almost a cliche at this point. 🙁

– Ron

There’s still a center, but it’s doing what the center always does in times like this … we wall ourselves away inside our own individual gardens. We don’t engage. We don’t answer the phone. Ask anyone on the sell-side how their business has been over the past six months.

To loosely quote a line from Jerry Maguire, you had me at funeral attendance. I’ve often pondered what it is that brings those who attend a funeral so close together and I think it’s because we see ourselves in that box in the not too distant future and would like to have someone there to mourn with and console our loved ones also. I too remember who has attended the funerals and wakes unfortunately associated with the family and friends I’ve lost and the kinship that lingers long after the sad day. The way you tied that together with your investment thesis further in the piece though was brilliant and struck a chord with me right to my soul. I have too often in the past let trades linger far longer than they should and it’s just recently I’ve learned to adapt a similar strategy that you described so well.

I also agree with your assessment of the political landscape we’re facing. I was truly hoping for an awakening with Trump’s election, but instead we’ve not only extended the vast divide which began in the Obama years, but have actually increased it to the point I refuse to listen to the radio news, read the WSJ or pay attention to anything except what’s playing on the Classical Rock station on XM. I guess it’s the “head in the sand” theory I’m abiding by, but I believe I’m taking a similar approach to the one described in your approach to a trade. Everything I’ve thought about politics and politicians has led me to realize we’ve all made a very bad trade these past 20 years and the sooner we bury it and go to a new investment the better. I just hope we’re all around to see it!

– John

What John calls “head in the sand” behavior is what I call “walled garden” behavior. It is the natural human response to a world being ripped apart by the centripetal spin of constant competitive games.

Has the change in politics from the cooperation game to the competition game occurred at other times in history? If so, how long did it typically last and was there a major turning point during that process that marked that it was coming to an end?

Alex

This is an area where history rhymes, not repeats. Generally speaking, the only thing that gets a group out of a Competition game is an overwhelming external threat, like a war or natural disaster. The earliest recorded example of this would be the formation of the Delian League after the battle of Plataea in 479 BC, where the Greek city-states put an institutional structure around their alliance against Persia. This famously ends up becoming just a veneer for the Athenian empire, which some might say is the likely future for more recent Delian League structures like NATO. Pretty much any institutionalized post-WWII regime (Bretton Woods, the United Nations, etc.) is an example of Coordination game promotion. My favorite take on this is Alan Moore’s Watchmen comic book series. Or you could watch the movie.

I think the below article might highlight how we can get back to the co-operative game. I had thought that Hillary should have chosen Kasich as a running mate (I am party agnostic – historically voted both parties) – while I can never prove it, but I think that ticket would have “won” going away and would have been healthy for the nation.

http://www.cnn.com/2017/08/25/politics/kasich-hickenlooper-2020-unity-ticket/index.html

David

Seeing a lot of these cross-party and centrist match-ups of late, most of which feature Kasich. I dunno … the problem with professional politicians is that they’re professional politicians. The thought of leaving the cozy confines of the Party behind is just overwhelming. And the problem with non-professional politicians is that they’re billionaires, with all the disastrous ego-driven consequences that brings. What we need is a grassroots movement that’s both above and below party politics.

I think the political side of the competition game was firmed up with the Obamacare bill. No Democrat dared vote against; no Republican dared vote for. I see that as the official “us vs them” game which legitimized identity politics and ushered in Mr. Trump, who is both coach and cheerleader for his team in the competition game.

Miles

In a lot of your writing, especially about Trump, you make it sound as if Trump is the one who broke us, who made the game go from cooperation to competition. In late 2015, early 2016 I reached the conclusion that the current monetary and trade system was unsustainable. And that was because the world has been functioning with a set of growth models that do not seem to deliver anymore (I would call them broken). Trump and Brexit happened later, I believe as symptoms.

I don’t think Trump broke us. The world broke in 2008 and for 8 years we tried to cope and then balance sheets decided we needed a change and that was Brexit and that was Trump. Now, I do agree that he is different. He is a very good persuader (con-man?) and he comes with different ideas than what we have been told over the last 30 years or so.

Trump is an actor with individual responsibility, but he is also a product of a system which stopped working. And the game became competitive before him (see the Eurozone negotiations, see the increasing trade disputes during Obama).

Hillary was the great pretender, the magical thinking priest. “We are one happy family, let’s hold hands and wish for the best” kind of thing. And I think that is why she lost. People thought they would get more of the pretense. Yes, it means stability, but is [it] also means not recognizing that the game had already changed. I believe many (especially lower income) households realized that “cooperation” had become an equivalent to “stuck”, because there was no more tide to lift all boats.

Nicolae 

It’s a fair point, that Trump is symptom rather than cause, and it’s the central point that my partner Rusty Guinn was making in his companion piece, “Before and After the Storm” (or as I like to call it, “Make America Good Again”).

http://www.digg.com/video/tree-ladder-whoops

Jeremy 

Thanks for sharing today. On the subject of going to the funeral and given your praise for Kevin O’Leary, knowing your appreciation for the cinema, you may recall Danny DeVito in Other People’s Money.

Steve

An indisputable classic.

I’ve been interested in bonsai for many years and got into it a bit more seriously a few years ago (except with tropical plants) as part of my pre-retirement planning. I’m actually more partial to the original Chinese form Penjing which is a bit more disorderly (contrarian?) and metaphorically anti CB style. (It also means that whatever look I end up with can’t really be a mistake either!)

“By and large, it seems that Japanese artists have a strong tendency to impose order on their creations, whereas Chinese artists appear willing to embrace a measure of chaos.

“Clearly, they are less concerned with rules and the pursuit of perfection. Does it mean that there are no rules in penjing at all? Absolutely not.

“Conversations with penjing artists reveal that they are less interested in displays of technical virtuosity and ideal form. Instead, they seek to capture and convey sentiment and mood in their work.

“Their goal is to reveal an inner beauty, an essence inherent in nature.” Read more: http://www.bonsaimary.com/Chinese-Bonsai.html

We’ll see if a computer algorithm can do that.

Brian

Even if this isn’t true (Japanese bonsai artists impose order while Chinese bonsai artists embrace an element of chaos), it sounds so smart and I want to believe it so badly that I am treating it as true. Much like most of our political discourse today.

Makes me think of a saying my mom learned from an Indian furniture dealer at the Dallas World Trade Center – “Show your face.” Wedding? Birth? Anniversary? Funeral? “Show your face.” This phrase has compelled me to put on many suits I did not want to wear and to take many trips to the hospital when I did not want to go. But there is always some joy to be found by doing so.

And I loved the part about the animals. Makes me think of an old Proverb I have taken to heart – “The righteous man cares for the needs of his animal, but the kindest acts of the wicked are cruel.” This one definitely gets me out of bed on nights when I realize no one fed the dogs.

Regarding the life cycle of animals. I have long held that as a society we lose something when people, especially kids, think food comes from the grocery store. I.e., when there is no dirt involved with plants and no blood involved with meat. Even at their young ages, I have made sure my kids have had plenty of both under their fingernails. They may end up favoring country clubs to being in the country, but they will at least forever own by experience the baseline understanding of the cycle of life.

John

I haven’t been able to bring myself to raise animals for their meat. I blame it on the kids, but actually it’s me.

An infestation of Oriental Bittersweet, privet or kudzu cannot withstand the focused attention of a herd of goats who will first attack the leafy greens and then the tender bark of the vines seeking the crucial inner bark which they will pursue all the way to the root. It is then the responsibility of the goatherd to move the goats before they begin to damage the desired grove, fortunately they barbeque up pretty good and I make an acceptable sauce…

Joe

But goats are so damn cute. And they’re good. In the moral sense, not the taste sense, although I suppose that, too. I’m so conflicted!

How can I, or any regular run of the mill person, practically and pragmatically get involved to help “design an operating system that can compete and win against the billionaires’ operating system when the reboot happens”? I am asking with deference and humbleness…I am asking because I see what you see…I am asking because we (Americans or humanity in general…more along the lines of being an American) are better than this. We are better than racial tension, Trump, Clinton, debt, in fighting, political nonsense, billionaires’ controlling, etc., etc., etc. (the etc’s could have gone on for a while). I am asking because words without action are like intentions and hell (the road to hell is paved with the very best of intention).

Daniel

I’ve been wrestling with your question (What do we DO?) for a couple of years now, and I’ve come to the conclusion that political action on a national scale (third party formation, marches, etc.) isn’t the way to go. Instead, it’s hyperlocal political participation (city councils, school boards, that sort of thing) plus a national blockchain-based technology initiative to record video news so that it’s searchable, discoverable, and unalterable. Sounds boring, but I think it’s a transformative movement that we can ALL participate in. I’ll be writing a lot more about this in the weeks and months to come.

I read a lot of financial newsletters. I have been associated with financial services for 35+ years. I have been to several goat-ropings, rodeos and state fairs, too. So, I speak with a modicum of knowledge.

I read this recent “Always Go to the Funeral” article. I hate to admit it, but in review, while it was entertaining, I gleaned no useful action tactics from the theme; though I must admit, it was well-written, as far as verbs & nouns are considered and with obvious learning from Shakespeare literature.

I am still waiting for some, ANY, direction from one of your articles. DO you expect to deliver an actual OPINION, with an action plan, soon?

Steve

Short answer: No.

Long answer:

  1. For regulatory purposes this note is considered to be “general market commentary” and not “marketing material”. The day I start writing about buying XYZ stock or ABC fund, everything I write has to go through a much more laborious and time-consuming compliance process, and I wouldn’t be able to publish to the broad audience that I want to speak to.
  2. I trust that my readers are smart enough to read a statement like “I think that inflation and interest rates are headed up, and will be moving up for a long time, with all the caveat emptor implications that brings for investors” and figure out for themselves what that means for an “action plan” for their portfolio.
  3. I’m a portfolio manager of a hedge fund and co-portfolio manager of a ‘40-Act mutual fund, one of which reports its positions publicly on a quarterly basis (HF) and one on a monthly basis (MF). It would be … highly problematic … for me to write about “actionable ideas” in ET when I’m already acting on them in an undisclosed way within these portfolios.
  4. Even if none of the above constraints existed, I still wouldn’t write about buying XYZ stock or ABC fund. The world has enough touts financial newsletters as it is. There is bigger game afoot!

“Small-l liberal virtues” are philosophically opposed to “really old school notions like feudal bonds of personal obligation and trust.” The two cannot coexist.

The community supports both social and economic inequality (that’s the feudalism of which you speak). It will, either gently or not-so-gently, repress the upstart individual.

For his part, the liberal individual supports, as you note, free markets and free elections. But these are precisely the things that undermine the feudal organization’s bonds.

You are struggling to resolve the conflict that has perplexed us since the dawn of history. There is no known social organization that can capture the best of both small-l liberalism and the best of the bound community. The two have philosophies, bodies of knowledge that ultimately conflict.

John

To your point, I’m not looking to establish some sort of communitarian/liberal combo society, because I think you’re right about the incommensurability of how one defines justice and the good life within these two world views (Michael Sandel was on my dissertation committee). But I do think that there’s a sense of interpersonal obligation away from the State that’s front and center in, say, feudalism and theocracies and other admittedly illiberal societies, that is an extremely healthy corrective for the bastardization of liberalism that we live in today. Liberalism frowns on notions of personal obligation outside of contracts or self-interest, and you have to go to fairly extreme Rawlsian contortions to incorporate them. I’d like to incorporate more directly this communitarian gene of interpersonal obligation — a graft, to continue with the arborist metaphor — to create a liberalism that can stand up better to the Statist onslaught. Does that make sense? It’s a long putt, for sure, but worth the effort.

Horsepower

Cosmic JD tractor déjà vu. The exact same tractor is parked in my hay barn, along with cool attachments that make it so versatile. Brush hog (on my second one, destroyed the first one through sheer stupidity) rotary tiller (don’t try and plant wildflower plots without it) and the piece de resistance here in the snow belt, the snow blower with the six foot wide box. Heaven is a snow storm and 3 foot drifts on a long driveway. The farmer next door who taught me to run it scared the crap out of me by starting my tractor lesson off with “Up hill, down hill, never side hill. This thing will kill you” Then proceeded to list off all the people that had been killed on rollovers around us. So there are probably old farmers, and there are bold farmers, but there are no old, bold farmers. Kind of like PM’s huh? My first year with it I ran it out of fuel while using the bucket to clear the driveway (pre snow blower era, the dark days) at 5 in the morning in sub zero wind chills. Found out quick you have to bleed diesel lines when you run out of fuel, unlike a gas engine with its fuel pump. Neighbors got a big kick out of that epic fail. Why would anyone want a Porsche when you could have a JD? Thanks for being one of the really insightful commentators out there, there is hope for this business after all I guess. And if not, I’ve got some more wildflower plots to put in. Thanks for your work.

Mitch

Exactly like PMs. There are no old and bold portfolio managers.

I’m at the state fair in WI watching horse pulling right now. You’re right about that collar, this is incredible.

Adam

Changed the course of Western civilization.

As I was born in 1957, putting me in the largest birth year cohort of the generation. I can say from experience that low interest rates have caused me to save more not spend more. The whole Fed program of low rates since 1999, when Greenspan panicked about Y2K, has screwed savers and retirees (if they have any sense of risk). If interest rates were higher (and they manage to sidestep massive losses from the adjustment – e.g. at 1.9% inflation, in the old days the 10-year would be around 6%) maybe they would spend more and increase overall demand in the economy?

Jim

YES.

But there IS a way back. And, no, not an individual, but a connection between the physical world and the intangible world of investing. We actually had it for quite some time and it seemed to work as a means of preserving a means of measuring the success of prosperity.

It is gold.

How much should the balance sheets of the world contract? By maintaining the balance between the demand for money and its supply. Or by keeping the price of gold stable; adding to supply when its price dips below a target or vice versa if its price should rise above.

Of course the VALUE of gold doesn’t change – you can’t manipulate it which is the source of its beauty (indeed its supply vastly outstrips any slight demand for it) – central banks actions simply increase or decrease the value of money relative to a stable unit of account.

You are lost in the world of interest rates. Interest rates are NOT the price of money; they are the price of credit. If you can make the leap, the rest is easy.

You can have stable money and volatile (freely market based) interest rates OR unstable money and stable interest rates, but you can’t have both.

All the best. And, yes, we should build a statue to the man (woman?) who invested hydraulics – a genius to be sure; but also the creator of some fairly dangerous equipment.

Charles

I’ve been promising Charles a Mailbag note for a while.

From my perspective, Uncle Sam, Japan, and the Euro Block (and probably others, certainly China) are hopelessly indebted with no natural way of escaping their debt tsunamis.

Thus I think it likely that each such country or block’s central bank will buy and forgive ALL or essentially all such debt in “exchange” for a new regime of fiscal realism and a corresponding new currency such as the “New Dollar”.

I wonder what your thoughts are of the likelihood of this, and what would be the best positioning for individual financial survival?

Gary

If things get bad enough, I don’t think this is a crazy scenario at all. Google “trillion dollar coin” if you want to see how close we’ve gotten already. This is Jubilee, and the survival scenario is pretty simple — be a debtor in a developed country participating in the Jubilee. Even a creditor can do okay, because you’re going to get unbelievable political power out of this. Just don’t get caught outside the Jubilee zone.

Your comment suggests that Uber is actually able to make transportation a breeze, but this service doesn’t happen to increase overall economic productivity in line with consumer appreciation of its service. This is wrong. If you look at the actual economics of Uber’s business model and the economics of urban taxi service, you will quickly see that Uber’ isn’t just “relatively unproductive”, its productivity impact is powerfully negative. Uber is substantially less efficient than the traditional taxi companies it has been driving out of business, and has absolutely no hope of achieving profits or shareholder returns unless it achieves Amazon/Facebook like levels of artificial market power. Companies like Amazon and Facebook can reduce productivity and overall economic welfare once they achieve the levels of artificial market power they now enjoy, but in order to achieve that power they actually developed highly productive operating models and introduced totally new products offering huge new consumer benefits. Uber’s business model was always designed to skip the hard “figure out how to provide services vastly more efficiently than existing providers” part of the equation, and have been using $13 billion in VC cash to achieve industry dominance by subsidizing the huge losses needed to drive existing providers bankrupt. Capital Markets—by explicit design—have been reallocating capital from more productive to less productive uses. If successful, a handful of billionaires would become even more wealthy, but overall economic welfare and the productivity of urban transport would be significantly reduced.

Hubert

I drive for/use Uber because:

  1. My college degree is worthless.
  2. I can’t get a “real” job.
  3. I’m in debt.
  4. I can’t afford a simple house and car in the suburbs.
  5. I’m what you might call “poor” in old-school terms.
  6. All of the above.

anonymous

Heard.

The movement you speak of in the last paragraph… is that demand created by Adam Smith’s unseen hands? What will drive it? As you know from previous communications I think that the low productivity growth is partially driven by the unmeasured deflation inherent in your first explanation of measuring productivity all wrong. We measure productivity in terms of growth of output dollars per man hour. But in a deflationary environment we can grow output in units while the dollar value of that output declines (we have exchanged notes on that before). But I think the same phenomenon is responsible for the low wage growth to boot. So many commentators are puzzled by the fact that, given all the stimulus we have injected into the economy, why we have seen no inflation? My reaction is, given the tech revolution going on, we are in a sharply deflationary environment so the fact that prices haven’t gone down, shows the stimulus HAS brought inflation. But that inflation merely has brought price declines to zero. I.e. if we start with, say, 6% deflation but prices are flat, it means the easy money has generated 6% inflation that offsets. I also think that population demographics have a lot to be explored further. If our population is getting older and birthrates are insufficient to replace, we start trending down in the number of people. That has to have a depressive effect on GNP. But look at Japan, they have stably sustained such an environment for decades. So it strikes me that the relevant measure may not be aggregate GNP but GNP per capita. I.e. you can sustain negative GNP growth as long as it declines at a lower rate than the underlying population such that GNP/head (wellbeing?) is actually growing.

All of this is well and good, but given the explosion in worldwide debt it is still dangerous. The best way to fix that problem is inflate our way out of it. And for that we need real absolute growth. You suggest that that will come from your Maker Movement. But I am wandering what will spark that movement into being?

Jacob

A small group of thoughtful, committed citizens. It’s the only thing that ever has.

Is it also possible that productivity has collapsed because of the burden of over-extended government regulation in a post-GFC world?

Take financial services for example. Let’s say headcount has stayed constant. The make-up has changed materially. We have fired 4 traders and/or analysts and hired 1 programmer and 3 compliance offices.

Buy and sell side alike. With SarBox, Dodd-Frank, Volcker Rule, MiFid II, Basel III, short-sale restriction etc. the massive growth in headcount has been on compliance officers and paralegals and not every programmer is replacing the former traders or analysts but some are coding to prepare reports sent to regulators, exchanges or investors. This is the high of a productivity free fall.

I can’t speak to other industries as directly, however, I imagine directionally the pattern is similar.

Rich

I used to pooh-pooh the whole regulatory burden thing as more of an excuse than a reason. But I was wrong. The struggle is real.

Good stuff as always, but your analysis of the buybacks misses one key point – buybacks are a return of capital and you do not know (cannot know, actually) how that capital is being used. So on a superficial level you can say capital is not being reinvested, but in fact it very well may be – in fact, probably, since most shares are held institutionally, and the cash received would stay in a portfolio and be reinvested elsewhere.

The desirability of buybacks is debated perpetually, but I fall on the side of favoring them. If management really does not see a good real use for the capital, I would prefer it be reinvested elsewhere, rather than wasted internally on inferior return projects. I think this is healthier for the economy too.

As an aside, I think the “lack of productivity” issue is a measurement problem. There are a hundred little things that technology enables nowadays that we take for granted, and would be productivity killers if we lost them – but I don’t see how we can measure it. For instance, try calling an airline to book a ticket rather than using Expedia. You will waste a half hour on a 5 minute task. Or ordering anything on Amazon, versus driving to 20 stores looking for it. Or count the number of emails and texts you send in a day, and consider the time that would be required to make the same communications by phone call. Start looking for these instances in your daily life and you will quickly realize the productivity gains that we are making, without realizing or measuring it. “Things produced” may not show it, but time saved certainly would!

Gary

Reinvestment in public markets never gets to the real economy. Never. I know we’re all taught that S = I, but not all I is created equal.

Trust me, I get the power of stock buybacks, and I’ve had this use-of-cash conversation with management in hundreds of 1-on-1s. That’s literally hundreds. But the inferior return of investments in plant and equipment in a ZIRP world is exactly my point!

As for the “time savings” argument … hang on a second, I gotta check my Twitter account and see if I’ve topped 10k followers yet … that’s big, you know?

As always, great piece. I would add one more explanation to the “low productivity” problem. Whereas in decades past, employees would spend minutes a day on break or at the water cooler, they are now spending hours at their desks on social media, yet employers still report them working 40 hours per week. The reality is that many of these employees are actually working for 35, 30, or even fewer hours per week. What this does is increase the denominator and make it look like productivity per hour is low. The reality is that we should be measuring actual hours worked rather than hours in the office.

This is not just a theory, as there is abundant anecdotal evidence. I am 45 and spend approximately 0 hours on social media, but have asked millennials about it and they confirm my suspicions. They even talk about being criticized for not “liking” comments and photos fast enough. How can you “like” something that quickly if you wait until you get home that night?

Surprisingly, I have read very few articles about this explanation presumably because well-known economists are 50+ and use social media about as often as I do…

Sean

I think this is a big reason why our “time savings” from technological process conveniences (Google, Amazon, etc.) never translate into production or productivity. We amuse … hang on … YES, I’ve topped 10k followers! … seriously, go see @epsilontheory … finally! … ourselves to death.

Really enjoyed your expansion on why productivity hasn’t risen as much as one would suspect from technology. I think it may be due to the “Slacker Effect”.

I have noticed that many young people nowadays graduate from college and don’t really want a “real job”. Even though they are well educated and smart, they prefer to do something pretty mundane and low pressure. Often they provide some kind of personal service in an area they are interested in such as personal training, dog walking, or personal assistant/nanny. Of course there isn’t a whole lot of productivity gains possible in those fields and it doesn’t leverage their education and abilities very much.

It does dovetail nicely with inequality, since there is a good sized population of extremely rich individuals who desire a lot of personal services.

Basically, we have developed a small producer population that is enormously well compensated, leads very high pressure lives, and is serviced by the rest of society.

So in that way the changes we have seen with economic inequality and low productivity gains are politically stable and actually desired by much of the population. Probably destined to continue, notwithstanding hand wringing by economic bloggers.

Keith

Now read this …

Maybe I’m missing the point of “Horsepower”, but if you are advocating for making and buying stuff over seeking out experiences, whether as a provider or a consumer, or both, I think you are completely off base. Marx was all wrong about economics and politics, but, oddly for an academic, he showed some insight on actual life when he inveighed against soul-destroying alienation. And it seems to me that what’s important about your tractor (to you – not me, and not the economy in general) is not the making of it (which would best done by robots), or the buying of it (which decreases your freedom of action in life by decreasing your stock of money), but the experience of using it, whether or not you ever turn a notional “profit” on what you do with it, or contribute to the GDP. The value of stuff to humans lies in the positive experiences they derive from it, and as your Emily Dickinson quotation avers all we need to make a prairie is reverie.

As even high level “white collar” jobs are overtaken by AI-driven automation (yours, financial analyst – my former job, software developer) it can beneficially force us to rethink our lives, devolve economically (scaling back both our getting and spending), and focus more on what’s truly most valuable to us – the pursuit of just the right mix of personal experiences.

John

Yes, I agree.

I agree that you’ve missed the point of “Horsepower”, you’ve missed the point of Marx, and you’ve missed the point of Emily Dickinson. There’s a whole Jamie Lee Curtis riff on this in one of my favorite John Cleese movies, A Fish Called Wanda, but I’ll save that for another day.

The part that struck a chord with me was the marketing of an experience based economy over stuff.

As millennial living in Sydney Australia, I have seen many of my friends adopt that experience oriented mindset which encompasses – going to clubs and raves, extravagant holidays and buying food at work. Which equates to zero savings and even going into debt whilst still living with the parents when they all have well-paying jobs.

As a poker player, I interpret this behaviour as going on tilt. An indirect wave of the white flag over prospects of home ownership (prices are crazy) and a lack of trust in the social contract. You are completely right in seeing this as a distraction but calling it “experience economy” ennobles and empowers this irresponsibility. As a society, you can have another generation with the same bad financial habits of the previous.

I see real danger in this trend and the stakes are underestimated. Because if too many liabilities are places into the future, it means too many liabilities are placed on the government and most social upheavals are the result of such economic problems. This will increase the intensity of identity politics and fans the fires of resentment of the have-nots. I am a small L Liberal because as a child, I heard stories of the Cultural Revolution from my dad. Once a significant portion of the population is poor, you really see the dark side of human nature come out, there will no longer be any small L liberals. My grandfather was a farmer’s son who became a surgeon who donates most of his pay to the relatives who are still struggling farmers. As an individual, he should have been a poster child of the rags to riches story. In the identity politics of the Cultural Revolution, he was categorized as the elite and social parasite and rallies were held to berate him and his cohort. If capitalism is perceived as failing, the stakes are enormous to human liberty and rule of law.

Shaun

Well said, Shaun. Well said. I’ll stake you any day.

Before and After the Storm

I often think that the big divide in this country is between Rural and Urban.

Currently, I see amazement among (I suspect) Urban writers re the Volunteerism in Houston. But it doesn’t take a large-area emergency for this to happen. Fully 1/3 of our National Population is served by Fire Cos. that are Volunteer. I suspect the numbers are similar for EMT’s. In Rural America, it’s a daily occurrence.

Ron

YES.

Rusty’s piece is superb. I love the Durant book that he recommends. He fails to mention that it’s only about 100 pages. There’s no excuse for people to *not* buy it and read it. I have a first edition on my office bookshelf. My *only* quibble with the book is that they understand the broad sweep of history, but get things wrong about the decade in which it’s published. They perceive the civil rights movement as a minor passing thing, rather than a seminal change in racial attitudes. And – get this – they dismiss Warhol as ridiculous non-art that will be forgotten in no time! I think the book should be required reading for all University history majors … except the chapter on current events (i.e., the 1960s).

FWIW, I’d say the same thing about “Devil Take the Hindmost,” published in June 2000, which is a fantastic book about bubbles and crashes, but didn’t treat the tech bubble with anywhere near the wisdom or depth of previous cycles. In other words, historians should stick to history, not current events that haven’t yet revealed their historical role or import.

Rob Arnott

I’ve got The Story of Civilization set in my office … they were my father’s, and the pages are all marked up with his underlining and notes. It’s my best connection to him, gone 20 years now.

The inclusion of ARC on your list of “vetted” charities makes me think that it is not a very good list.

Al

Yes the American Red Cross was vetted, yes we’ve read the Pro Publica report (and others), and yes this is the subject of a vigorous internal debate at Salient. I respect your negative experience with the ARC, although I’ve had a very different experience and am convinced by the commitment of the volunteers and paid professionals I know there.

Ultimately it was my decision to include the American Red Cross on the list of recommended charities, and I stand by that decision.

Last summer we had the opportunity to drive through Houston and the whole area en route to a vacation cruise. We noticed two things:

  1. the area is massively overpopulated; and
  2. it’s low.

As we traveled toward the gulf, we noticed it seems the entire region is only two feet or so above sea level. We thought how lucky the people in these areas have been. A tsunami from an earthquake or volcano will literally wipe out vast areas and millions of people – living where they ought not to live.
Or a real genuine large hurricane with 175 -200+ mph winds with a 15 – 20 storm surge going onshore.

Instead, at this time mild mannered Harvey came but with lots of rain!

We noticed the TV videos of the flood areas and they appeared to be connected to rivers. Indeed, it was obvious that the worst areas, maybe all areas, were floodplains. 100% certain to be engulfed in water. With more than 100,000 homes ruined, it suggests the scope of the destructive policies.
Then we learn that the Houston, specifically, area has little if any development zoning controls.
Likewise, Katrina in New Orleans flooded places where no development should have ever been done.
Increasing population in our already overpopulated country implies greater calamities around the corner.
Seems you are missing the point.

Trying to make the world feel sorry for bad things that happen to people and will happen because of destructive policies is not helpful. To be certain, those people we see are living a very sad situation.
But the situation was caused by developers and their government subsidiaries. Incredibly, they prey on entire populations.

Totally avoidable.

Dell from Minneapolis

My first instinct to this letter was to respond with anger. I mean, I was going to tear Dell from Minneapolis a new orifice. Really let my freak flag fly, you know? And I still can’t help myself completely. It’s just too enticing, what with the whole “en route to a vacation cruise” set up. But then I read this below, from a Team Elite Ministry of Truth platform called Project Syndicate.

Hurricane Harvey has left in its wake upended lives and enormous property damage, estimated by some at $150-180 billion. But the rains that inundated the Texas coast for the better part of a week, and the hurricane that is about to hit South Florida, also raise deep questions about the United States’ economic system and politics.

It is ironic, of course, that an event so related to climate change would occur in a state that is home to so many climate-change deniers – and where the economy depends so heavily on the fossil fuels that drive global warming. Of course, no particular climate event can be directly related to the increase in greenhouse gases in the atmosphere. But scientists have long predicted that such increases would boost not only average temperatures, but also weather variability – and especially the occurrence of extreme events such as Hurricane Harvey. As the Intergovernmental Panel on Climate Change concluded several years ago, “There is evidence that some extremes have changed as a result of anthropogenic influences, including increases in atmospheric concentrations of greenhouse gases.” Astrophysicist Adam Frank succinctly explained: “greater warmth means more moisture in the air which means stronger precipitation.”

To be sure, Houston and Texas could not have done much by themselves about the increase in greenhouse gases, though they could have taken a more active role in pushing for strong climate policies. But local and state authorities could have done a far better job preparing for such events, which hit the area with some frequency.

In responding to the hurricane – and in funding some of the repair – everyone turns to government, just as they did in the aftermath of the 2008 economic crisis. Again, it is ironic that this is now occurring in a part of the country where government and collective action are so frequently rebuked. It was no less ironic when the titans of US banking, having preached the neoliberal gospel of downsizing government and eliminating regulations that proscribed some of their most dangerous and anti-social activities, turned to government in their moment of need.

There is an obvious lesson to be learned from such episodes: markets on their own are incapable of providing the protection that societies need. When markets fail, as they often do, collective action becomes imperative.

And, as with financial crises, there is a need for preventive collective action to mitigate the impact of climate change. That means ensuring that buildings and infrastructure are constructed to withstand extreme events, and are not located in areas that are most vulnerable to severe damage. It also means protecting environmental systems, particularly wetlands, which can play an important role in absorbing the impact of storms. It means eliminating the risk that a natural disaster could lead to the discharge of dangerous chemicals, as happened in Houston. And it means having in place adequate response plans, including for evacuation.

Effective government investments and strong regulations are needed to ensure each of these outcomes, regardless of the prevailing political culture in Texas and elsewhere. Without adequate regulations, individuals and firms have no incentive to take adequate precautions, because they know that much of the cost of extreme events will be borne by others. Without adequate public planning and regulation, including of the environment, flooding will be worse. Without disaster planning and adequate funding, any city can be caught in the dilemma in which Houston found itself: if it does not order an evacuation, many will die; but if it does order an evacuation, people will die in the ensuing chaos, and snarled traffic will prevent people from getting out.

America and the world are paying a high price for devotion to the extreme anti-government ideology embraced by President Donald Trump and his Republican Party. The world is paying, because cumulative US greenhouse-gas emissions are greater than those from any other country; even today, the US is one of the world’s leaders in per capita greenhouse-gas emissions. But America is paying a high price as well: other countries, even poor developing countries, like Haiti and Ecuador, seem to have learned (often at great expense and only after some huge calamities) how to manage natural disasters better.

After the destruction of New Orleans by Hurricane Katrina in 2005, the shutdown of much of New York City by Sandy in 2012, the devastation wrought on Texas by Harvey, and now the prospect of Irma pummeling Florida, the US can and should do better. It has the resources and skills to analyze these complex events and their consequences, and to formulate and implement regulations and investment programs that mitigate the adverse effects on lives and property.

What America doesn’t have is a coherent view of government by those on the right, who, working with special interests that benefit from their extreme policies, continue to speak out of both sides of their mouth. Before a crisis, they resist regulations and oppose government investment and planning; afterwards, they demand – and receive – billions of dollars to compensate them for their losses, even those that could easily have been prevented.

One can only hope that America, and other countries, will not need more natural persuasion before taking to heart the lessons of Hurricane Harvey.

Joseph

This is not from Dell from Minneapolis, driving through Houston on his way to a cruise and making some off-the-cuff and ignorant comments. This is Joseph Stiglitz, Nobel Prize winner. This is Joseph Stiglitz, former chief economist of the World Bank. This is Joseph Stiglitz, former chair of the President’s Council of Economic Advisors. This is Joseph Stiglitz, former chair of the U.N. Commission on Reforms of the International Monetary and Financial System. Dell from Minneapolis is not one of Time magazine’s 100 most influential people in the world. Joseph Stiglitz is.

Now I’m not going to get into a blow-by-blow response to this Stiglitz piece, although like Dell from Minneapolis’s masterwork, there are some flowers here that I can’t help but pluck (“America and the world are paying a high price for devotion to the extreme anti-government ideology embraced by President Donald Trump and his Republican Party.” If only we had had a president for the past eight years who considered climate change to be our #1 national security concern. Just imagine how much better off we would be today.).

But I’ll say this. The smiley-face authoritarianism that oozes from this article, the not understanding and the not wanting to understand the facts of Houston and Harvey, the global system that awards Stiglitz — an intelligent man who knows better — its highest accolades and sweetest rewards for his betrayals of truth-seeking, the sheer mendacity of the effort … this is our enemy. It’s my enemy, anyway. And combating it will be a life well lived.

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