How Can People Be This Stupid?

This is a question that all of those who take their cues from Austrian Business Cycle Theory ask quite often. Psychologists have certainly found fertile ground discussing money's ability to distort rational and moral decision making capabilities. Over the past couple of decades neuroscientists have been taking a look as well.

Doug French over at Mises.org has written a couple of essays on this topic:

https://mises.org/blog/testosterone-and-madness-central-bankers

https://mises.org/library/does-neuroscience-support-austrian-theory

French highlights a study showing that unexpected windfalls, such as those generated by central bank money printing, release dopamine into the brain. Dopamine, according to Psychology Today, helps control the brain's pleasure and reward centers.

French, from the first linked article:

With the world’s central banks flooding the world with liquidity pushing interest rates to nearly nothing, bubbles emerge, pop, and emerge again. Yet people never learn.

John Coates, a Canadian-born research fellow in neuroscience and finance at the University of Cambridge and a former trader at Goldman Sachs and Deutsche Bank, believes he has the answer. 

“Once you start making above-average profits, as most people do during a bull market, you start getting this high,” he says. “I think it’s enough to pretty much squash memory” of previous bubbles. 

Coates himself, equipped with a PhD in economics, has fallen victim to the testosterone highs. “I don’t think I ever would have hit on this if I hadn’t experienced it myself,” he says. “We have an unstable biology, and it’s very powerful.” (emphasis added)

Powerful enough that someone as brilliant as Sir Isaac Newton went broke chasing the South Sea Bubble. Newton piled into South Sea Company shares early and sold early at a profit. However, “he then watched with some perturbation as stock in the company continued to rise.” 

Newton bought back in near the top and sold near the bottom. This prompted him to allegedly say, “I can calculate the movement of stars, but not the madness of men.” 

Central bankers, throughout history, have created madness. Their treachery continues unrelenting.

One aspect that I find interesting is the idea that dopamine is released only when people have unexpected gains. This fits with the idea that investors over time become like drug addicts, and take increasingly stupid chances in the search for gains and that dopamine high. The FANG stocks, ICOs, Tesla and Uber seem like perfect examples this time around.

Whether all of this fits with Austrian Business Cycle Theory is really beyond my circle of competence. I am also afraid to ask myself if I secretly have some type of financial death wish. As opposed to most investors, is my unwillingness to sell gold and buy equities telling me that my dopamine response is triggered when central bankers smash my positions? Perhaps there is some genetic mutation in me that enjoys a little financial masochism.

Hopefully I am saner than that, but the articles are an interesting afternoon diversion.

Malinvestment Example

This WSJ article gives us a pretty textbook definition of the Austrian concept of malinvestment. Here are some snippets:

Easy Wall Street cash is leading U.S. shale companies to expand drilling, even as most lose money on every barrel of oil they bring to the surface....

The new wave of crude has again glutted the market. The shale companies are edged even further from profitability, and a few voices have begun to question the wisdom of Wall Street financing the industry’s addiction to growth.....

Wall Street has become an enabler that pushes companies to grow production at any cost, while punishing those that try to live within their means, Mr. Walker said, adding: “It’s kind of like going to AA. You know, we need a partner. We really need the investment community to show discipline.....”

“There’s been insufficient discrimination on the part of sources of capital,” said Bill Herbert, an energy analyst with Piper Jaffray’s Simmons & Co. International. Big shale companies “are able to get what they want and invest what they want.”


In some ways, investors’ willingness to subsidize shale losses—as long as they come with production growth—echoes wagers made on technology companies such as Amazon.com Inc., which lost money for a time before becoming profitable. Investors are betting on which companies can best weather the storm of low prices, and, once it subsides, swing toward profits or growth that will fuel a rally in shares....

TAI again: This last paragraph highlights the paradox of investing under artificially low rates. Demand for capital is fooled by the low rates and undertakes projects with long paybacks and long time horizons as the low rates make those things appear profitable. Savers, the supply of capital, crushed by low rates, see their time horizons collapse and become consumers and stop providing real capital. Voila, the wasting of what little capital remains. The mismatch of time horizons between those who supply and demand capital ensures that there will not be enough capital available to see projects to profitability.

Initial Coin Offerings

This article on coin offerings makes understanding the euphoria here, for the issuer anyway,  pretty simple. Issuing equity as a tech start up is now far too expensive relative to issuing coins. Coins are like gift cards, something that you can turn in for a product or service in the future. They represent a liability on the offering company's balance sheet, just like debt, but there are a couple of added benefits IMO. First, no one ever expects these coins to be redeemed since they are really speculative tools (it is free money). Second, tech products and services decline in price so even if they are redeemed down the road, the cost of providing the service will have fallen. In short, these ICOs are like issuing massively negative yielding bonds. If we think equity and bond prices are too high, what does this tell us about coin prices?

Trapped

Between December 30th of last year and April 21st, the ECB grew their balance sheet by 476.5 billion euros. That is a very dramatic rate of money printing, far faster than the absurdly gargantuan sum of 60-80 billion euros per month that Draghi has promised.

Why the panic liquidity surge? I think that most are assuming that after the Brexit vote and Trump's win that central bankers have had enough with elections sowing fear, uncertainty and doubt over the financial markets. They were taking no chances with the French presidential primary.

We have arrived at a funny place in monetary history. A primary election in a minor league economy now requires a liquidity surge that is far greater than in any recession we ever saw prior to 2008.

And Europe isn't alone. The money printing by global central banks is running faster now than any time since 2008. We are nine years into our supposed recovery and central banks still feel the need to print at ever faster rates:
(From Business Insider)


The conclusion that we should draw is that central bankers are trapped. They have promised that financial markets will remain elevated and stable. They won't even let a primary election in a minor economy impact financial markets. I can only imagine the response that a recession would bring.  If the rate of debasement slows it seems nearly certain that financial markets will implode. The Global Financial Crisis was so calamitous that central banks have guaranteed that it will never happen again.

Sure, there may be periods where central banks will say they are going to get tough, but no one really believes this. Here is a retail investor in China that sums up perfectly the investment wisdom of our time:

April 10 – Bloomberg: “Like many individual investors in China, Yang Mo has no idea what’s in the wealth management products that make up a big chunk of her net worth. She says there’s really no point in finding out. Sure, WMPs invest in all kinds of risky assets, but the government would never let a big one fail, she says. ‘It’s not how the Chinese government does things, and it’s not even Chinese culture,’ explains Yang, a 29-year-old public relations professional… Hers is a common refrain in Asia’s largest economy, where savers have poured $9 trillion into WMPs and similar products on the assumption that they’ll get bailed out if the investments sour. Even after news in February that policy makers are drafting rules to make it clear that state guarantees don’t exist, Yang is undaunted… ‘Cracking down on implicit guarantees is just like curbing home prices,’ she says. ‘It’s something that the government needs to say, but it’s not something they will eventually do.'"

(emphasis added)

This is where we are and it is universal. There is no fear about overpaying for assets because central bankers have their backs. Unfortunately, central banks can guarantee nominal asset prices, but only at the expense of  the eventual destruction of their currencies.  If they could stop the printing, they would have done so by now. They are trapped.

Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.




 

The Beepi Economy

A story on failing start-ups in today's Wall Street Journal caught my eye and I thought that I would use it to illustrate a point in Austrian economics. In fact, it may be the point of Austrian economics.

Just a quick refresher here:

Austrian economics posits that if interest rates are held at artificially low levels, the structure of the economy can become (massively) distorted. Artificially low interest rates depress the level of savings and raise the demand for real capital. That is, lower rates make projects that have a payoff farther in the distance relatively more attractive. The artificially low rates won't provide enough savings to get you to the distant payoff, however. Low rates are not the panacea that investors believe.

This is a problem. It is a problem that we saw develop during the tech bubble at the end of the last century, and it is the same problem that the housing bubble saw a decade ago. Now it is a problem again during the everything bubble.

The aforementioned Journal story starts off with a mention of Beepi Inc., a California based on-line used car business that I didn't know existed. They burned through $120 million in cash before being cutoff from the money trough.

The article points out that investors prefer crowding into fewer, bigger companies. You know, companies like Airbnb and Tesla. These bigger companies are so capital voracious that they have literally squeezed out the smaller fry. There is nowhere near enough real savings in the system to fund all of these businesses. The same is true of older line companies as well. IBM can't try to grow any longer, nor can Caterpillar. Real investment is falling with interest rates at zero. Isn't this the opposite of what economists told us would happen when they embarked on this dramatic course of free money.

Money is not the same as savings. Money can tell you who has access to savings (deferred consumption), but it is not savings itself. While a business is trying to develop or invest in new projects or facilities, real savings is required to be lent to or invested in the business so that those building the facilities or writing the code can pay their rent and food bills while the project moves ahead. Just printing money from thin air doesn't provide the real goods and services that are needed by these people. Only real savings does this. Savings drives growth. Money creation from thin air inhibits it by crushing savers.

Sadly, central bankers are set on the annihilation of savers and the now former savers have decided instead to become consumers. There is lots of demand to try to create businesses that may be profitable 20 years from now because interest rates are near zero percent, but there isn't enough savings out there any longer to get these businesses to the self sustaining finish line.

We saw this model play out in 2000 in the tech companies of the day. The internet start-ups were axed from the money trough and investors then crowded into shares of Cisco and Microsoft. Hey, we'll always need routers and operating systems they thought.

Sure, but not nearly as many as people thought. Growth couldn't be maintained because of a lack of savings. Today, we are repeating the same mistake, only on a far bigger scale.

There will be those who will insist that the winners will make up for the losers. This is unlikely. Just in the U.S., the system that the Fed has engendered is creating claims on good and services of about $5 trillion per year (growth in household net worth). The problem here is that GDP growth and the level of savings are only creating about $1 trillion per year in incremental things to buy. This is a problem for which there is no painless solution.

It is a Beepi world out there. Be careful.

Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.

The Inner Ring and Propaganda

Some of the recent discussions regarding propaganda have had me thinking about the relationship between propaganda and morality in professional money management. The following from CJ Hopkins at counterpunch.org struck a chord when I read it:

The primary aim of official propaganda is to generate an “official narrative” that can be mindlessly repeated by the ruling classes and those who support and identify with them. This official narrative does not have to make sense, or to stand up to any sort of serious scrutiny. Its factualness is not the point. The point is to draw a Maginot line, a defensive ideological boundary, between “the truth” as defined by the ruling classes and any other “truth” that contradicts their narrative.
 
Imagine this Maginot line as a circular wall surrounded by inhospitable territory. Inside the wall is “normal” society, gainful employment, career advancement, and all the other considerable benefits of cooperating with the ruling classes. Outside the wall is poverty, anxiety, social and professional stigmatization, and various other forms of suffering. Which side of the wall do you want to be on? Every day, in countless ways, each of us are asked and have to answer this question. Conform, and there’s a place for you inside. Refuse, and … well, good luck out there.

Fund managers have clearly been beaten into submission for a generation now by the money stick wielded by central banks. Bet against the asset bubbles they create for even a moment and you will quickly find yourself on the outside. Central bankers have eliminated all dissenters from the investing world. All those who remain as professional investors are now forced to mindlessly repeat the official narrative. Even as the narrative moved from central bank control of elevated asset prices to the fiscal policies of Donald Trump, no investor has dared to utter a discouraging word. Be bullish and repeat the official narrative or find another profession is the new reality of the money management business.

All of this brings me to a warning issued by that middle-aged moralist (as he called himself), C.S. Lewis. Lewis once delivered a commencement address titled The Inner Ring, where he warned against both the desire of becoming an insider (someone supposedly in the know) and the fear of being an outsider.

I believe that in all men’s lives at certain periods, and in many men’s lives at all periods between infancy and extreme old age, one of the most dominant elements is the desire to be inside the local Ring and the terror of being left outside....

And you will be drawn in, if you are drawn in, not by desire for gain or ease, but simply because at that moment, when the cup was so near your lips, you cannot bear to be thrust back again into the cold outer world.....And then, if you are drawn in, next week it will be something a little further from the rules, and next year something further still, but all in the jolliest, friendliest spirit. It may end in a crash, a scandal, and penal servitude; it may end in millions, a peerage and giving the prizes at your old school. But you will be a scoundrel.

Of all the passions, the passion for the Inner Ring is most skillful in making a man who is not yet a very bad man do very bad things.

Lewis recognized that desire to be on the inside, as well as the terror of being on the outside, can lead people to abandon their principles and become scoundrels. I am almost certain that much of professional money management is now full of scoundrels all too willing to blather that central bank theft via the printing press and government control of the economy are creating real wealth. It is now too cold and forbidding on the outside of the ring for them to any longer contemplate a life there.

I was reminded of the depth of the investing propaganda again this week as CNBC trotted out Warren Buffett to cry to never bet against America while proclaiming that the U.S. possesses some "secret sauce" that insures that asset prices will always rise over time. I often wonder if Buffett's more principled father would view his son as a scoundrel?

I will finish with a rather ominous warning from another middle-aged moralist from the past century, Dietrich Bonhoeffer, that seems appropriate to the discussion of propaganda:

It seems that under the overwhelming impact of rising power, humans are deprived of their inner independence and, more or less consciously, give up establishing an autonomous position toward the emerging circumstances.
 
The fact that the stupid person is often stubborn must not blind us to the fact that he is not independent. In conversation with him, one virtually feels that one is dealing not at all with him as a person, but with slogans, catchwords, and the like that have taken possession of him.
 
He is under a spell, blinded, misused, and abused in his very being. Having thus become a mindless tool, the stupid person will also be capable of any evil and at the same time incapable of seeing that it is evil. This is where the danger of diabolical misuse lurks, for it is this that can once and for all destroy human beings.