The Market Mind Hypothesis, page 4
To give a brief flavour of the symposium, I opened it by sharing a kind well-wish from George Soros which he had sent me by email earlier that morning:
Dear Patrick, I am pleased to receive your update on the Market Mind Hypothesis. I hope your Panmure House symposium will be successful. I couldn’t attend because I am giving a speech in Davos on May 24th which I’m sure you will read about. As you can see I remain actively engaged in the affairs of the world but as I told you before, my days as an active philosopher are over. That’s just as well because all great philosophers are dead. I hope you will carry on with your own contributions to reflexivity.
The academic speakers at the symposium included distinguished economists Sir John Kay and Anatole Kaletsky, neuroscientists Karl Friston and Scott Kelso, behavioural experts Gerd Gigerenzer and Nick Chater, and philosophers Julian Kiverstein and Duncan Pritchard. The investment speakers included Emanuel Derman, Dylan Grice, Howard Marks, and Kiril Sokoloff. They were joined by policymaking experts, including Sir Geoff Mulgan as well as representatives of the Bank of England and the IMF. Numerous investment professionals of reputable investment firms and other academics from international universities completed the audience. Honouring and building on Smith’s legacy, the symposium launched our research programme, spearheaded by the Market Mind Hypothesis (MMH). In 2023 we will celebrate the tercentenary of Smith’s birth, in our case by firmly establishing this programme, hopefully housed in its own research centre.
This book introduces the MMH, a novel economic theory that I have been developing over many years, now increasingly with interdisciplinary collaborators. It complements but mostly challenges mainstream economics. Various economic crises were systemic—to the point of being existential—and almost prevented you from reading it. Instead, they now offer it inspiration, in a radical empirical sort of way: mass anxiety about the unknown mixed with mass mania about easy answers. It all got fuelled by unlimited amounts of money created from thin air. Leading to interest rates and oil prices that first went negative and then dramatically turned. And it spawned addictive apps to trade virtual assets. All very surreal. How to make sense of it?
This book is deliberately targeted at an interdisciplinary and multigeneration audience. In the Introduction I’ll explain in more detail why the book is important in light of our economic predicament and how it came about, with the symposium as a seminal event. For now, it is important to that wider public because each of our lives is deeply influenced by (collective) decisions, policies, regulations, and strategies that are based on and justified by mechanical economics, the dominant economic theory I will criticise shortly. So it is crucial to understand how it has contributed to our predicament and what can be done about it. The latter not only makes this a hopeful book but also a book of action, especially education wise. In short, economics is too important to be left only to economists.
In terms of style, I very much wrote this book as a devil’s advocate, often explaining topics in black-and-white terms to get my points across. I hope its critical tone does not put off mainstream economic readers. It is nuanced by my own experience of working with savvy economic and investment professionals. I know that the discipline is capable of introspection, self-criticism, and renewal and I hope this book will help those attempting to improve economics in formulating their own critiques and solutions along similar lines.
With that caveat, a quick recap. The Global Financial Crisis (GFC)1 initially centred on the 2008 collapse of the US investment bank Lehman Brothers, but subsequently morphed into the similarly systemic euro(zone) crisis which started in late 2009. The global economy subsequently struggled to recover and never really returned to health. Then—with a morbid symbolism—the corona virus hit in 2020, exposing that weakness which resulted in the Corona Virus Crisis (CVC). Although less prominent than Lehman it was preceded and accompanied by the so-called Repocalypse: stress in repo and other interest rates that also reached systemic risk levels.2 The UK recently suffered a specific crisis in liability-driven-investment (LDI) whereby the central bank (BOE) had to step in to avert pension funds’ insolvency and further contagion. Finally, in the Spring of 2023 US regulators shut down the Silicon Valley Bank (SVB) and First Republic bank, the largest bank failures in the US since 2008, to prevent contagion. And in Switzerland UBS had to take over Credit Suisse. To top it all, we have been in a “cost of living crisis” due to record inflation. This book will argue that these are not independent incidents, but symptoms of a deeper and ongoing crisis in economics itself, with which we view and treat the economic system. For example, the nature of contagion—for us as conscious agents—has changed due to digitisation as the culmination of mechanisation, especially via digital apps and digital currencies (see Subchapters 6.3, 7.2, and Chapter 11).
Those of us who were ‘in the market’ at those times, especially during the GFC, most vividly remember what it felt like. Regardless of whether you were a bull or a bear, we all became rabbits caught in the headlights of those events. During that time, several observers labelled the economic system as “weird”, as in surreal. I call these existential crises “reality checks” (Schotanus, 2013 and Schotanus, 2020):
Q: Why is all this so surreal?
A: Because that is what a reality check is about.
Q: What does it entail?
A: Reality checks make you realise; in an ‘in-your-face’ manner. Your beliefs, based on stories, are checked against your actual experience, the sensations you feel. This is experiential valuation.
We are still trying to get to grips with the aftermath of these crises, leading to a lively debate over both their causes and their cures. Many academics, practitioners, and policymakers participate in this debate because they realise that there are lessons to be learned. However, what is required is no ordinary learning. Reality checks are often extremely painful, like a rude awakening. And they have consequences. In the words of Larry Summers: “something is wrong with the economics profession if events like those of 2008 do not change its thinking” (2018). One critic even declared “The End of Theory” (Bookstaber, 2017). Andy Haldane asked after the GFC (specifically regarding policymaking): “If a once-in-a-lifetime crisis is not able to deliver that change, it is not clear what will?” (Haldane, 2012). What about a second-in-a-lifetime crisis? Or a third? No, it doesn’t seem that way. Borrowing its (in)famous “as if” concept: as if nothing has happened, mainstream economics hasn’t learned.
However, not only were these crises existential in that we came close to economic collapse, a.k.a. financial Armageddon. They were also ontological, concerning the very nature of financial markets and the broader economic system, showing that some of economics’ “as if” assumptions are serious category errors. Crucially, this is about “whether human mental activity is machine simulable or not” (Spear, 1989, p. 891), which mainstream economics thinks it is, as part of its wider mechanical worldview. This is exemplified by Robert Lucas, one of its architects, who thinks of economics as something that can be put on a computer and run (see my full quote in Chapter 2). Combined with our ongoing plight as its consequence, this forces a thorough rethink of economics and the economic system; the MMH contributes to this endeavour. Regarding ontology, it particularly emphasises that the current paradigm is mistaken about its mechanical view of what the economy, the market, and their agents are.3 Specifically, mechanical economics views (and treats) the market as an automaton. But the market crashing was far from anything mechanical. Especially for those in the market who had skin-in-the-game it didn’t feel at all as some kind of mechanical failure, like a car breaking down. Instead Mr Market4 forcefully reminded us that we are him and he is us—a collective, animated being with intersubjectivity. Essentially, sensing his mood we became painfully aware that he was about to go brain-dead and enter a coma. In his 2009 investment letter, legendary investor Seth Klarman called it a “near-death experience”. What stood out was the shared sensation of anxiety, a mental paralysis, which irreducibly accompanied the market’s physical seizure. It was this overwhelming experience that impresses what it is like to collectively be in such a market state as humans. Just like taking snapshots of neural activity won’t capture perceptual experience, static analysis of the ‘mechanisms’ of economic crises don’t convey (existential) market mood.5 In short, agents imply agency. But mechanical economics ignores that our agency is born from consciousness. As economist Frank Knight reminds us: “The first datum for the study of knowledge and behavior is the fact of consciousness itself” (Knight, 1921, p. 200).
This hints at the importance of cognitive science—an interdisciplinary field that studies minds—to help revise the paradigm. Specifically, combining cognitive science and economics the MMH submits the Market Mind Principle which states that markets and minds are very much alike. As I’ll explain, the dynamics within our individual minds are acted out collectively in markets, with multiple feedback loops. Crucially, informed by cognitive science the MMH formalises what investors have always casually assumed, namely that the market has a mind. The message of him almost going brain-dead (twice!) is thus—first and foremost—about saving Mr Market and sustainably restoring his health as well as, by extension, that of the economy:
the financial system [is] the brain of the economy … It acts as a coordinating mechanism to allocate capital, the lifeblood of economic activity, to its most productive uses by businesses and households. If capital goes to the wrong uses or does not flow at all, the economy will operate inefficiently. (Mishkin, 2006)
From the outset, let me make my position here crystal clear in terms of the distinction between entity (or creature) consciousness and state consciousness (e.g. Dretske, 1997, p. 98). I consider the market as collective entity to be conscious under normal circumstances, when its agents are consciously discovering prices. It physically freezing up for a prolonged period—thereby suspending price discovery—is comparable to an individual going brain-dead. In that ‘vegetative state’,6 while some level of consciousness could remain, we no longer would consider the market to be conscious entity wise. At best, it would show apathetic and uncoordinated consciousness. I’ll return to this later.
Unfortunately, many still believe this debate is simply about reaffirming more strongly the post-GFC conclusion that markets are the problem, that they can’t work without central planning, and that we should get ready for a new kind of socialism—spearheaded by financial repression—that replaces capitalism. This belief is problematic on so many levels.
First, it is mostly based on biased and superficial analyses of worrying symptoms observed more widely, like debt addiction, environmental degradation, (geo)political tensions, inequality, non-inclusion, productivity slowdown, and zombie companies. The fact that they all continued to deteriorate while (the supposedly beneficial) state influence expanded over the decades should raise red flags that something common and more fundamental is wrong. We have gradually moved from a relationship society to a transaction society, with the growing mechanisation of markets playing a major role in this shift. Society’s economic challenges are characterised by ‘more of the same’ in that regard, and the sad irony in mechanical—and thus repetitive—thinking itself as dogma lies at its roots. Regardless of whether Einstein actually said it or not, repeating the same thing but expecting different results is insane. This unfortunately now applies to the economics profession where the majority somehow expect to find different answers to our predicament by repeating the same thinking, often in a more extreme form (like modern monetary theory or MMT). Instead we get positive feedbacks and cumulative effects that only exacerbate the situation. All mechanical economics can think of is to throw yet more automation, more debt, and more price distortion at it.
Second, it naively seeks inspiration from the past ‘successes’ of centrally planned economic activities by countries like China, Japan, Korea, and even Finland. What is forgotten is that these successes were largely achieved on (and regularly over) the backs of global open markets. Moreover, totalitarian regimes have economically survived chiefly because they are on the markets’ coattails, often funded by uncritical investors. Now their growing presence and bad influence are a threat, not just to markets but to free minds generally. We should have known better, and the words of George Santayana come to mind: “Those who cannot remember the past are condemned to repeat it”. Still, ESG investing—selecting securities based on Environmental, Social, and Governance criteria—can potentially play a constructive disciplinary role, as I’ll explain in the first Economic Note. More generally, the MMH argues the case against central planning and totalitarianism, and for individual freedom, initiative and responsibility. What makes it novel is that it is based on scientific cognitive insights, complementing traditional political libertarian arguments. In the words of Giuseppe Vitiello: “‘It doesn’t need a conductor’ is the consciousness. It integrates all of it [into] the combo”. (See full quote in Subchapter 3.3.)
Third, the new socialism encounters the reality of our debt situation which epitomises ‘more of the same’. In principle credit can help to create a desired future by financing some self-repaying requirement for that future today. This is its beneficial purpose. However, it also leads to a temptation to do more ‘on credit’ without strict self-repayment preconditions. Unfortunately, recent generations could not resist these Faustian bargains and this has resulted in dangerous indebtedness. For example, the Institute of International Finance estimates that the global debt-to-GDP ratio exceeded a record 350% by the end of 2022. And the Bank for International Settlements (BIS, the central bank of central banks) warns that the US$ 80trillion of off-balance sheet dollar debt via foreign exchange swaps and forwards exceeds the stock of traditional short-term dollar debt which may lead to a dollar funding squeeze. To paraphrase Margaret Thatcher, we’ve already run out of other people’s money. Consequently, we have now resorted to borrow excessively from future generations. That’s politically convenient as they have no vote in it and being told, via Keynes, that all this doesn’t matter because “in the long run we are all dead” kind of sucks when you are not even born yet. Such dismissal of the interests of future generations is, in the words of polymath Frank Ramsey, “ethically indefensible and arises merely from the weakness of the imagination”. It also gives rise to growing intergenerational tension, which falsely gets attributed to side-show debates. Youth’s anger at Wall Street and the Covid lockdowns is nothing compared to their anger at lockups of future earnings to repay past debts. To top it all there is the deteriorating demographic situation, due to aging populations.
Moreover, such a belief seriously underestimates the type of rethink required and suggests we would, as per Santayana, not learn any lesson. Rather, as I mentioned, we need to revise our economic understanding at a deeper level. This most crucial lesson is not easy to learn. The reason is twofold. First, due to mainstream’s mechanical worldview our profession has become obsessed with modelling. Confusing the map with the territory has come at the expense of understanding. Understanding, particularly in an ontological sense, is difficult and involves more than just mechanically following instructions. The famous outburst by Richard Feynman comes to mind:
I don’t know what’s the matter with people: they don’t learn by understanding; they learn by some other way—by rote or something. Their knowledge is so fragile.
Second, and related, it requires unlearning existing false lessons which continue to be taught, for example to (aspiring) investment academics and professionals. This book attempts to help in that revision endeavour.
A key issue that highlights the relevance of cognitive science is that of mental causation.7 For example, in economics we generally assume that inflation expectations can cause inflation itself (e.g. Friedman, 1968; Phelps, 1967; but see Rudd, 2021). However, the overarching example is the wider relationship between the market’s mind and the real physical economy. It showed a dangerous tail-wagging-the-dog dynamic during the systemic crises, which made many experts conclude that this mind~matter interaction is a key lesson. Specifically, Nobel laureates George Akerlof and Robert Shiller—inspired by the implied dualism of animal spirits8—recognised that:
We will never really understand important economic events unless we confront the fact that their causes are largely mental in nature. (Akerlof and Shiller, 2009, p. 1; emphasis added)
Numerous researchers have addressed mental causation, including economists. Reflecting on consciousness versus physical conduct, Knight, for example, admitted that “it is surely evident that we cannot logically regard the conscious state as causing or explaining the conduct in any significant sense. And yet we do, habitually, and for all practical purposes universally, look at the matter in just this ‘unscientific’ way” (Knight, 1925a, p. 378; emphasis added). Others include Friedrich (von) Hayek and Ludwig (von) Mises,9 the latter—importantly—in the context of the famous mind~body problem:
But notwithstanding the advance in physiological knowledge, we do not know more about the mind-body problem than the old philosophers who first began to ponder it … Thoughts and ideas are not phantoms. They are real things. Although intangible and immaterial, they are factors in bringing about changes in the realm of tangible and material things. (Mises, 1957, p. 65; emphasis added)
The mind~body problem, to which I’ll return in the Introduction, concerns the (e.g. causal) relationship between mind and matter. Even famous physicists acknowledged it: “Physics relies on a mirror symmetry between mind and nature … which is most tightly related to the psychophysical problem” (Pauli, 1957; in Atmanspacher and Primas, 2006, p. 20). Shortly before he died Ilya Prigogine, answering a question about future scientific challenges, stated that “if I was a young researcher now, I would study the mind-body problem. This is the great challenge of the 21st century”.
