The Market Mind Hypothesis, page 17
Moreover, putting mechanical economics into practice—by implementing mechanical methods, policies, regulations, strategies, and techniques—creates an environment that is favourable to mechanisation, further reinforcing it. Mechanisation begets mechanisation (see Figure 2.2 and also Appendix 1):
Figure 2.2: Mechanisation begets mechanisation.
Yellen, Powell, and other men-of-system are blissfully unaware of this. They are like that old cartoon joke of an unempathetic doctor. When asked by their bedridden and ill patient (in our case Mr Market): “What’s wrong, doc?”, they look around and reply that the roof leaks, the windows are broken, and the place needs some painting.
Mechanical economics’ blind spot—as Knight identified in 1925—is the fact that humans have conscious minds with which we experience the world. Specifically, connected via trading and supported by way of technologies our minds collectively extend into real and financial markets (see next subchapter). That includes our consciousness: it does not somehow get cut-off, or remain unaffected, let alone vanish. Instead, it is critical for discovery, distributed market awareness and sensemaking. In the case of the CVC it exemplified itself for many as lingering anxiety and outright fear. So, ignoring consciousness because it is inconvenient does not make it go away. Neither is thinking you have dealt with it because the assumption of complete knowledge somehow includes awareness. Crucially, there is nothing mechanical about consciousness, in particular the experience of discovery to which I will return later.
To further clarify the mind~matter complexity, let’s focus on debt for a moment. The total levels of debt (against GDP) suggest that our IOU-promises have grown to levels we simply cannot keep.30 An alternative, and arguably better measure is interest payments to GDP. It would signal a warning, for example, when it exceeds long-term average real GDP growth. In any case, this situation is the consequence of the rinse-repeat conviction that there is a need to turbocharge the economic machine by pulling future demand into the present. With credit as its tool, fuelled by ramshackle incentive structures and facilitated by central banks, it frequently leads to misallocation to financial and other unproductive assets, which can reach bubble territory. Credit plays its Mephistophelian role in two parts here. First, in terms of the alchemy of money itself, fiat money is created out of thin air supported by nothing but a promise. So, the first part is about money itself as IOU. Second, credit turns one feature of economic causality on its head: it facilitates consumption before production by transforming a future real asset into a current financial liability. In the real economy production (which generates income31) precedes consumption: you cannot consume something before it is brought into existence (and paid for/demanded by income). Income is thus an asset derived from physical assets and physical action performed by a body (labour) or a machine (manufacturing). Debt, on the other hand, is a financial liability derived from mental assets and mental action performed as trusting and believing, in other words having ‘faith’.
Next, it is not just the ratio of income and debt that counts. It is also how and where income, respectively debt, is spent in the real and financial economy that determines the sustainability of the economic system. Let me give a simplified and extreme example of gaming the economic system to make my point. Suppose a majority of companies in an closed economy issue debt. Instead of investing the proceeds in productive assets, they spend it on self-serving tax-free share buybacks for their executives. The latter, in turn, fire employees to further raise current profits. It turns out that those profits are largely tax-exempt due to ‘tax-efficient’ holding structures, so they don’t benefit society. This would add to imbalances in the economic mind~body. In short, income is earned only once and cannot pay twice, for both real consumption (by those employees as customers) and financial repayment.
Even before the recent turmoil the economic mind~body already showed zombie-like32 symptoms. Basically, interfering in price discovery and other self-organising processes prevents creative destruction, the natural cycle of economic life and death. Instead, the economic system becomes populated by zombies, with cheap credit sustaining these undead, whereby banks simply no longer price in default risk (Sekine, Kobayashi and Saita, 2003). More generally, the signalling by prices becomes distorted, consequently misguiding agents’ behaviour by misinforming their decisions. As a result, rather than reinvigorated, the economic mind~body becomes infected by attitudes and behaviours that weaken it. That is what zombies do, after all.
Economic Note Gaming Bailouts
Gaming the policy and regulatory framework, due largely to its inherent weaknesses including loopholes and vague criteria, is a consequence of mechanical control. It mostly exemplifies the removal of any spirit of the law. Again, machines do not get spirit.
One typical example occurred during the CVC. In March 2020 the Bank of England (BOE) launched its Covid Corporate Financing Facility (CCFF) to support UK businesses. Any losses by the BOE are covered by the UK Treasury, so the taxpayer to this day is on the hook. To qualify, companies had to have investment grade status and were not allowed to pay dividends, buy back shares or issue bonuses. Furthermore they also had to “make a material contribution to economic activity in the UK” and be “UK incorporated, including those with foreign-incorporated parents and with a genuine business in the UK”. As reported widely in the media, it turned out that the largest beneficiaries were controlled by billionaire families and overseas multinationals. Specifically, chemicals giant BASF received the highest amount (£1bn) despite only employing 834 people in the UK.
There are numerous other instances of such abuse across the world. Bloomberg, for example, reports that cheap-money policies of the US Fed designed, in cooperation with the US Treasury, to sustain employment were misappropriated: “Companies as diverse as Sysco, Toyota Motor Corp., international marketing firm Omnicom Group Inc. and movie-theatre chain Cinemark Holdings Inc. borrowed billions of dollars—and then fired workers”. The borrowed funds mostly went to buy back shares and pay dividends, benefiting company management and other wealthy owners of those shares.
If we look closer at central banks, for example, we can identify a couple of issues. Regarding the wealth effect that they promote as beneficial for the real economy, there is the issue of incentives. Taking Charlie Munger’s cue, Matt Stoller (2020) points out that important senior members of the Fed are multi-millionaires. After digging into their financial disclosure forms, he finds that they are all invested in types of indexes which strike him as violations of Section 10, part 5 of the Federal Reserve Act. He pointedly concludes that these officials have public positions in which their policy decisions affect their personal portfolios in similar ways. This has since become an ethics scandal and has resulted in the resignations of several Fed officials, including the then vice-chair Richard Clarida and Atlanta Fed chief Raphael Bostic. Clearly this doesn’t help their credibility.
The broader issue is the dubious motivation that tweaking the machine of the financial economy—through the printing machine and other monetary tools, like quantitative easing (QE)—will materialise as improvement in the machine of the real economy (like growth). This is a typical case of mainstream’s metaphysical assumptions which are Von Weizsäcker’s poorest ones33 at play. In short, what we observe with the recent crises is how category mistakes eventually lead to reality checks.
Besides ignoring consciousness, let’s be specific about why the REH, and by extension the EMH, offer an unrealistic view of human mentality (see also Appendix 1-B). I previously mentioned that the assumptions of exclusive rationality and self-interest are primarily based on convenience, namely that modelling becomes easier. Second, it assumes market participants have complete or perfect knowledge and have learned from their mistakes. And finally, they are assumed to be aware of all this.
This view has already been formally criticised by many (including Spear, 1989). In practice, new investors who have not yet learned from their mistakes join the market every day, while experienced investors leave. Also, much of the knowledge that drives investor behaviour is tacit. Then there are the biases and other unconscious drivers of which we are not aware. This behaviour is further compounded by the technological unconscious. As Herbert Simon argued in 1971, this makes investors bounded rational at best, aiming for satisficing outcomes (see also Evolutionary Rationality in Appendix 1-B4). Moreover, the REH assumes market participants do not change their forecasting strategies. Physically, this is as if brains are fixed. However, neuroscience has shown instead, that brains show impressive flexibility, including plasticity. In addition, modern cognitive insights suggest not only that our minds update their estimates but also the hypotheses underlying those estimates, which changes their forecasting strategies.34 This will be discussed in more detail in the next chapter.
This does not absolve behavioural economics (see Appendix 1-B4). It is, surprisingly perhaps, also guilty of subscribing to a mechanical worldview:
As different as their explanations are, behavioural economists … have followed their conventional colleagues in the belief that models must generate sharp predictions to qualify as scientific … Consequently, behavioural finance modellers also formalize individual decision-making and market outcomes with mechanical rules that they specify in advance. Whether based on the conventional standard of rationality or behavioural considerations, the contemporary approach to macroeconomics and financial modelling is thus much like engineering the movements of “interacting robots”. (Frydman and Goldberg, 2011, p. 47; emphasis added).
Earlier I raised the issue of the irony of behavioural economics. It teaches us that we are gullible. In particular, that we are easily convinced by our own opinions and become overconfident. It basically advocates to mistrust our own minds. As part of the wider movement in mechanical economics, we have seen this morph into a shift in allegiance: we now trust models and machines to the point of overconfidence. Like social media, their algorithms turn us into a kind of zombie.
As I’ll discuss in more detail in chapters 6 and 7, the element of surprise in discovery—especially its phenomenality—is very important. In terms of Shannon’s entropy, for example, when you are surprised and learn something new, thereby gaining knowledge, the information involved is maximized. In contrast, the mechanical perspective, and its related belief in engineering outcomes, leaves no space for surprises and the novelty that they spawn. External surprises are ‘anticipated’ (as in pre-determined) while internal surprises, i.e. insights to creatively deal with those external ones, are not required.35 It means that the resulting mechanistic approach to markets is not only ‘mentally constraining’ but dangerous because of the actions based on these flawed models that feed back into the economic mind~body. Crucially, because it crowds out creativity and sensemaking by zombifying conscious minds it has major implications for the full process of discovery, starting from technological breakthroughs in the real economy to the discovery of their prices in markets. In fact, discovery becomes a misnomer in a mechanistic economy, regardless of whether the latter is assumed or engineered as such.
Instead, based on the stylised fact that we are not machines but they our tools with which we extend our minds, the mind~body perspective, as advocated by the MMH, offers a more realistic, ontologically sound, and overall healthier framework. Mechanical economics is vulnerable to criticism because it has not joined the current phase of the cognitive revolution. Specifically, its premise embeds the reductionist assumption that the efficiency of the market can be fully explained by the rationality of its participants. Price discovery, enacted by trading, can—according to this view—be separated and isolated from supplementary developments in markets, in particular mood shifts. In other words, it assumes that equilibrium is an independent mechanistic process driven by the steady state of rationality. This insistence by mechanical economics on separation, identified earlier as part of a mechanical worldview,36 is quite broad (e.g. the real from the financial economy, the market from its participants, theory from practice, and rationality from emotions). It is at the core of its own identity crisis, as well as that of the market.
Let me try to explain this in a different way. Reality checks confound expectations. Statistically, this can be reflected, for example, in Mr Market’s skewness, ‘double-headedness’, and other return patterns that defy the normal distribution. Following Tarnas (in Harman and Clark, 1994), let me clarify this further in cognitive terms via the double bind concept of anthropologist Gregory Bateson in the next Cognitive Note (Double Bind).
Cognitive Note Double Bind
Together with his team, Bateson developed double bind to explain schizophrenia and PTSD as a result of conflicting messages (in relationships) between two or more people.
In this case I apply Bateson’s criteria to the relationship between a typical investor and Mr Market, conditioned by mainstream economics. Remember, the investor is trading with Mr Market, not directly with another individual; For example, they blame him for any ‘suffering’, like getting filled at a bad price. Also consider the opening quote from Barton Biggs in Appendix 1-C5.
Dependency: the investor’s relationship to the market is one of economic survival, thereby making it critical to assess the nature of the market accurately, so the investor needs to be engaged, or at least be aware of the market’s state. Remember the quote from Subchapter 2.1: “You’ve got to be in it all the time to know …”. That means they need to be able to receive its ‘signals’.
Communication: As a nested discipline within mechanical economics, finance prescribes how the market communicates, and its models suggest how information should be interpreted. However, the investor’s mind receives mixed messages: contradictory or incompatible information about the situation as experienced in the market. In particular, its interiority by way of inner qualitative sensations is incoherent with the prescribed scientific impressions (say, by model readings) of the market as its exteriority. Specifically, the mixed messages consist of the following:
Modern finance (i.e. the EMH): The market is efficient, so the price communicates nothing but rational behaviour. Irrational exuberance (Shiller, 2000) does not exist (because collectively we are all rational).
Behavioural finance: The market is anomalous, so the price communicates systematic non-rational heuristics and biases. Irrational exuberance exists (we all suffer from emotions, particularly collectively via herding).
The messages are inconsistent, except for one thing: they both suggest that there is no role for S1 inputs, e.g. emotions are irrelevant, respectively bad.
Epistemology/methodology: modern finance insists that the investor’s mind cannot achieve direct understanding of the market beyond public knowledge. Specifically, the investor cannot experience the price in a meaningful way, if only because price sensations (qualia, especially via mood)37 are considered epiphenomenal. Related to this is the issue that the only acceptable type of research method is analytical, which only supports S2.
Existentially: the investor collectivity cannot desert, nor can it contradict (read: beat) the market. But it can perish with the market.
It becomes clear that, in Bateson’s terms, the victim and the perpetrator are one and the same. Mr Market is a schizophrenic because we collectively create the separation of identities in one mind:
Like the post-Copernican dilemma of being a peripheral and insignificant inhabitant of a vast cosmos, mechanical economics suggests that the average investor is a disposable robot in a global economic machine.
Like the post-Cartesian dilemma of being a conscious personal subject confronting an impersonal universe, mechanical economics suggests that the average investor is a rational individual confronting the efficient market, itself a mindless but superior composite investor.
These dilemmas are compounded by the post-Kantian dilemma of there being no possible means by which the investor can know the market in its complete essence (see also Roll’s second critique, 1977).
Finally, to deal with the post-Kahneman dilemma between S1 and S2, behavioural finance suggests that a key (evolved) medium with which we build a relationship and understand another being, or even a collective group of beings, namely S1 (emotions), should be switched off. Instead we should optimise S2 by mechanically outsourcing decisions to machines.
Arguably separateness, which for our purposes is basically about ignoring consciousness, continues to linger. To some extent it is appropriate for the natural sciences,38 but it simply is not applicable to understanding markets. Consequently, as others have shown, the REH’s formal mathematics is about knowledge that cannot be both complete and consistent.
The mind~body perspective explicitly points to the deeper underlying problem of our incomplete knowledge, namely regarding the relationship between mind and matter. This has implications for economic utility (maximisation) because epistemic utility raises its head (something discussed by active inference; see Subchapter 3.4). As an aside, mechanical economics ignores the phenomenal aspect from experiencing utility by an agent, for example that of being immersed in consuming or using a product. This relates to Heidegger’s hammer analogy (Heidegger, 1927, p. 98; see also Dotov, Nie, and Chemero, 2010).
