The Market Mind Hypothesis, page 18
I also connected this previously to reflexivity. It seems that Soros was particularly inspired by Popper’s quoted reflections on the original mind~body problem when he stated his trading view of its extension: “What I could not properly resolve was the nature of the relationship between the [mental] mode of thinking and the actual [physical] state of affairs. That problem continued to preoccupy me” (Soros, 2010b, p. 8). Subsequently he has always insisted on the inseparability of economic facts and thinking agents, echoing his mentor’s interpretation of mental causation:
Thinking participants cannot act on the basis of knowledge. Knowledge presupposes facts which occur independently of the statements which refer to them; but being a participant implies that one’s decisions influence the outcome. Therefore, the situation participants have to deal with does not consist of facts independently given but facts which will be shaped by the decision of the participants. (Soros, 1994; emphasis added)
Here we are only interested in relevant facts: those that eventually become known to the participants as the verdicts on their decisions from which they learn. They arrive later and are experienced by agents as dually realised information in System 3 or S3 (see Appendix1-A4), all of which is outside their fast (S1) and slow (S2) thinking. This phenomenal ‘tasting of the pudding’, I submit, completes the loop of reflexivity because it connects the initial decision (made by either S1 or S2) via the accompanying feeling of ‘what it is like’ (in this case, to make an S1 compared to an S2 decision) climaxing in its (again, experienced) outcome. This is crucial for learning. Moreover, just to emphasise the importance of consciousness, the flipside of this is unawareness which has a growing literature (Schipper, 2021). An agent who is unaware of an event cannot even assess its occurrence/non-occurrence, let alone its meaning. I have more to say about this in Chapter 6.
Reflexivity itself has a rich history in the social sciences. A related modern concept is performativity, a principle described within economic sociology. Performativity, according to Michel Callon, one of its founders, is the process whereby economics and its models are actualised: they not only describe the markets but shape them at the same time. This echoes enactivism, suggests mental causation, and relates back to distributed cognition (which also has a rich history in sociology; e.g. Berger and Luckmann, 1966).
The MMH emphasises that the collective invasiveness of mentality, spawn by exchanges, is the most crucial aspect in economic dynamics. Although financial markets are exemplary of this in empirical terms, this collective dimension applies more broadly. Here, Roger Sperry already anticipated social neuroscience decades ago:
Mental forces direct and govern the inner impulse traffic … the causal potency of an idea, or an ideal, becomes just as real as that of a molecule, a cell, or a nerve impulse. Ideas cause ideas and help evolve new ideas. They interact with each other and with other mental forces in the same brain, in neighboring brains, and, thanks to global communication, in far distant, foreign brains. And they also interact with the external surroundings to produce in toto a burstwise advance in evolution that is far beyond anything to hit the evolutionary scene yet, including the emergence of the living cell. (Sperry, 1965, p. 82, 83; emphasis added)
There are many related variations of such causality. The more complex exchange between bottom-up and top-down causation is termed circular causality (Kelso, 1995) and the macro-micro feedback loop in complexity science. This type of causality is also recognised in ethology, the root of evolutionary psychology, and is called niche construction.39
The above makes clear that the assumption of separation between mechanical economics (as observer) and the market (as the observed) is untenable. Arguably this already starts to blur when finance academics participate in the markets, say by co-managing a hedge fund (e.g. LTCM) or simply by investing via their pensions.40 It becomes problematic if their models start to shape the objects they are supposed to only describe ‘objectively’.41 And it is tragically defeated if the founders themselves no longer believe in the assumptions, purpose, and applicability of their models. In the words of Markowitz (2005, p. 29): “My own conclusion is that it is time to move on”.
This puts a finger on the raw nerve of mechanical economics. Causality is central to modern science but has always been difficult to determine within the financial system. The traditional search is to find physical causes (reflected in economic fundamentals) for the mental reaction (reflected in price moves). Apparently fundamental news is not the sole source for price changes (e.g. Cutler, Poterba, and Summers, 1989). Regarding big macro events, in October 2000 the Federal Reserve Bank of Minneapolis held a conference on the great depressions across the globe during the twentieth century. None of the presented research found causes for them. The editor of the Minneapolis Fed’s Quarterly Review, Art Rolnick, instead concluded that “economists are, indeed, storytellers”42 (in Fettig, 2000). No wonder Shiller is endorsing narrative economics (which largely originates with McCloskey).
Economic Note Capped CAPM
The Capital Asset Pricing Model (CAPM) is the cornerstone model of Modern Portfolio Theory (MPT), both based on the EMH. It provides a framework to describe (expected) risk and return and draws conclusions, among others, on the efficiency and optimality of portfolios, including the market portfolio.
Although it remains central to the practice of mean-variance optimisation of portfolios it exemplifies the erroneous assumptions underlying mechanical economics and the empirical implications which follow from this. Specifically:
The CAPM is not logical, let alone realistic in its assumptions. In particular, the assumption of being able to borrow limitlessly is wrong which means that if “investors have limited borrowing capacity, then it no longer follows that the market portfolio is efficient”. (Markowitz, 2005, p. 17)
The CAPM is not tractable, nor testable. In particular, “the market” as a portfolio cannot be observed (Roll’s second critique, 1977).
The CAPM is therefore not empirical because we cannot make any meaningful statements due to the failure of both 1 and 2.
These difficulties lay bare the epistemological, if not ontological, issues involved in markets. They have been compounded by the ‘radical empiricism’ of the reality checks. As I mentioned, the future is not just unknown. It is unknowable, and it is this that men-of-system can’t seem to accept, not realising that with their algos and models they implicitly (by “as if”) assume a holy grail. Instead of wasting time on coding such ‘holy grail’ models, men-of-system should spend more time on “inquiring” (as in Heidegger, 1927, p. 24) and asking fundamental questions instead of making model-convenient assumptions. In psychology terms, infinite complexity due to mind~matter exchange is their complex. More generally, mainstream economics puts the cart before the horse: the theory had to be shaped first such that it could justify tractable mathematical modelling by a science that pretended to be ‘exact’ in order to appear authoritative. That was the priority, reality be damned. Add to it Friedman’s instrumentalism to motivate developing models as tools for those ‘authorities’ to project they are in control, and it becomes clear why mechanical economics has prevailed. Instead, all should take heed from the earlier warning by Derman. Inspired by Spinoza and others, he explains—with true authority and clarity—the limitations and risks of models in a beautiful little book, Models. Behaving. Badly. (Derman, 2011). In that spirit I like to paraphrase boxer-philosopher Mike Tyson (“Everyone has a plan until they get punched in the mouth”): Everyone in mechanical economics has a mechanical model until it breaks down in the face of psychophysical complexity. Increasingly we are all painfully losing as a result.
In the final analysis, this demands of economics a premise which, at the very least, reflects an acknowledgement of these issues. Perhaps surprisingly, such a premise already implicitly exists—at least among actual market participants—namely that of the market’s mind, and it leads to the proposition I will discuss next. It is based on leading edge cognitive theories, to be introduced in Chapter 3, which centre on 4E cognition. These attempt to explain the nature of mind and consciousness in general, and address, directly or indirectly, the hard problem in particular.
2.4
Market Mind Hypothesis; An Initial Proposition
We may, then, set aside the conception of a ‘collective consciousness’ as a hypothesis to be held in reserve until the study of group life reveal phenomena that cannot be explained without its aid. For it may confidently be asserted that up to the present time no such evidence of a collective consciousness has been brought forward.
William McDougall The Group Mind, 1920
2.4.1
The Market’s Mind
Much has happened since McDougall wrote these words. How far have we travelled since then to consider this final frontier of human mentality? In cognitive science, and regarding consciousness in general, some distance I would say. My Introduction quoted neuroscientists Christof Koch and Giulio Tononi on the science of consciousness. In terms of group consciousness, there is growing support from 4E cognition research, frequently pointing to its conditional role. Overgaard and Salice state that “if there is no such thing as group consciousness, then we cannot literally ascribe beliefs to groups” (Overgaard and Salice, 2019, p. 1).
In the economic system we have also come a long way. The influence of the financial markets on society, particularly by means of financialisation, has grown. To put a number on this,43 the value of all listed stocks in the world increased from roughly 20% of global GDP in the 1980s to almost 140% in 2020. The value of bonds also exceeds 100% of global GDP. In other words, the value of traded stocks and bonds (so, even if we exclude other securities, like derivatives) exceeds 250% of the world economy. On the one hand financial innovation produced derivatives, securitisation,44 and other risk sharing solutions. Based on money, which itself relies on a faith/trust foundation, this influence resides firmly in the mental domain. These solutions removed common risks and related worries about physical issues, like housing, bodily ageing (i.e. retirement), and the weather. On the other hand, and consequently, this development has revealed collective mentality phenomena with ‘tail-wagging-the-dog’ effects. In short, the mental is seriously overweight against the physical. This and related issues require cognitive explanations, as discussed in the Prologue.
Looking at theory, despite their differences, the main academic factions studying economics already seem to agree, at least implicitly, on the foundational assumption underlying the MMH. It can be stated as follows:
Financial markets form a complex composite of a large number of interacting human minds whose mentality, connected and extended by way of technology, is reflexively expressed in prices and their patterns.
I specifically use the term mentality because I deliberately want to include all properties and capabilities of the human mind, if only because none of the factions explicitly excludes any.45 In terms of thinking, for example, I do not want to discuss here whether it is rational or not. Neither do I wish to make the distinction between discretionary thinking, expressed in manual buy or sell orders, and mechanistic thinking, expressed in coded orders via computer algorithms. Instead, what is crucial for now is that this agreement ultimately leads to the MMH’s main proposition:
The market extends investors’ minds, distributes their knowledge so it can be shared, and manifests collective consciousness via intersubjectivity, with prices as informational signatures and market mood as its phenomenal experience.
Criticism that the MMH is unrealistic because the technologies which connect investors ‘would also have to be conscious’ is based on a misinterpretation of extension. In one of his strongest defences of the Extended Mind Theory, Clark states:
Suppose it were essential, for any system to count as properly cognitive, that the system be capable of conscious awareness. We would not want to insist (indeed we would be crazy to insist) that every proper part of that system be capable of such awareness. (Clark, 2010, p. 89).
Let me also be very clear on something else of importance, emphasised in general terms by Coordination Dynamics. There is no dichotomy anywhere, because the investment variation to Clark and Chalmer’s question (i.e. “Where does the investor mind stop, and the rest of the market begin?”)—like its original—cannot be answered as there is no clear cut-off/separation. Consequently, asking specifically whether the market has or whether it is a mind is simply missing the point. The market mind embodies—through the market microstructure, which includes the biological substrates of our bodies—all the investors’ minds while itself being embodied, embedded, enacted, and extended in a wider environment. What sets it apart (but not in a dichotomist/reductive way) is the mentality over and above the individual mentalities due to those conscious minds exchanging, leading to intersubjectivity and the like. In complexity terms, the whole of the market mind is “both more than and different from the sum of its complementary aspects considered in isolation” (Kelso and Engstrøm, 2006, p. 47). This ‘excess’ is the unique characteristic that investors experience (phenomenally) as mood. To conclude, based on 4E cognition the market mind results when conscious human minds—supported by technologies and tools—exchange, in the process discovering prices. Among others, because cognition and consciousness often overlap and cannot be isolated (e.g. Kiverstein, 2016), distributed cognition implies distributed (or collective) consciousness. Still, while comparable in some respect, the market mind is not the same as any individual mind.
Cognitive science recognises degrees of consciousness which vary across species. To determine this for other complex adaptive systems is difficult. Still, as part of its working hypothesis the MMH submits that as a very rough approximation, the market’s degree of consciousness, measured at any time T, correlates with three variables (in a yet undetermined relationship):
The number of conscious idd-minds making discretionary investment decisions.46
The number of securities that are ‘alive’ in that market, i.e. illiquid (or zombie) securities are excluded, identified by way of stale prices, for example.
The number of price changes across those securities (compared to T-1).
There are various levels of analysis which can help explain this proposition further, whereby each compares it to our own minds. I start with translating 4E cognition for the market’s mind.
2.4.1.1 The 4 Es of the Market’s Mind
The market mind is embodied, embedded, enacted, and extended. I will explain each. This eventually leads to the MMH argument that the complementary market forces, viewed in a 4E cognitive setting, can be related to the macrofoundations in economics if we freely interpret the latter as augmenting and supporting discovery (e.g. via pricing) to coordinate economic activity.
Embodied
The market mind is embodied because its mental efforts essentially depend on the physical structures—including human bodies, buildings, IT, and screens—in which it is incorporated. The felt quality of disappearing liquidity, for example, cannot be divorced from key bodily parts—the financial system’s plumbing, including (physical) collateral chains—freezing up. More generally, as Charles Schwab’s chief investment strategist states, “the plumbing system that connects QE (or QT) to asset prices is indirect and complex … while the psychological system connecting them tends to be more direct” (Sonders, 2021). I will discuss the market’s body in more detail in Subchapter 2.4.2.
Embedded
The market mind is embedded because its mental efforts are situated in the wider economic environment which offer opportunities and threats. Its environment includes cultural traditions, legal frameworks and rules of engagement (e.g. Granovetter, 1985; Clark, 1996). Culture, for example, is a key intersubjective force that, like a mortar, binds physical and psychological elements of the market. Referring specifically to my earlier ‘market completeness’ comments according to Arrow and Sen, it fills gaps with morals and values thereby upholding the market’s psychophysical architecture across individuals. As part of its total package, culture enables the market to help solve societal problems that individual genetics, S1 (emotions), nor S2 (rationality) can achieve. In cognitive terms, its environment provides the market “affordances” (Gibson, 1979), which can be constraining, liberating, protecting, and so on. For example, it forbids to trade on inside information. In contrast market interference and manipulation mean, as I stated before, that criticism of “free markets” is a straw man.
Enacted
The market mind is enacted because it is a complex adaptive system that not only relies on its environment (due to its embeddedness) but also acts upon it. Its states lead to changes in the world that both shape and are channelled by existing transmission structures, for instance the design of market (micro)structure, processes, and products that facilitate capital flows. History is full of stories how Mr Market changed our wider economic setting, with the industrial revolution as its pivot. One example of such a story in the physical domain is funding for infrastructure, like rail roads and residential housing. An example in the psychological domain is risk sharing (hedging) using derivatives. Such market-induced changes in the world feed back into market activity, in an example of the kind of reciprocal, circular causality emphasised by enactive approaches to the mind, like sensorimotor enactivism. See Gallagher, Mastrogiorgio and Petracca (2019) for further explanation.
Extended
