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?