The Market Mind Hypothesis, page 47
Now, imagine that the MMH becomes accepted, thus changing the paradigm: academia, industry and policymakers recognise the market as our composite mind~body instead of an inanimate machine that stands in isolation. Accepting the MMH has many implications. Key among them is the removal of the separation condition of the mechanical worldview (see Appendix 1). Once you acknowledge consciousness as fundamental and pervasive there is namely (see Harman, or Kirchhoff and Kiverstein) no clear separation between mentalities. It means that issues that are of concern to a free and healthy human mind are suddenly of concern to the market mind, and vice versa. In other words, the collective market mentality includes the social, in terms of human values. This particularly applies to ESG and related issues. To paraphrase Clark and Chalmers: where does individual morality end and market morality begin? Coming back to my earlier comments in the first Economic Note in this book, promoting yourself as a leading ESG investor while stating that: “We are not trying to set the moral compass” (as an ESG fund manager said to the Financial Times) is thus utterly inconsistent, naïve, and unsustainable (pun intended). Adam Smith would be disappointed.
It is through collective consciousness, the intersubjectivity consisting of shared experiences, that physical boundaries disappear, particularly those between minds and the wider world. Of course, there will still be parties who would want to manipulate the economic system (perhaps because they continue to believe that it is a machine, or because their authority or salaries depend on it). However, what would happen if our view changed in the manner that Thomas Kuhn describes? Assuming such a change would include the clearer conviction of society’s self-hurt caused by such manipulation, I submit that we will punish them much harsher than we have done over the past few years with the bank bailouts and the FX/Libor scandals. It also raises the bar for central bank policies in that decision makers will feel much more responsible for and sensitive to their actions and will be scrutinised more closely. I suspect they will revisit and likely revise the monetary toolbox.
I am well aware that I risk sounding like a broken record player. Still, I cannot emphasise this enough: that what makes us human is—more than anything—our consciousness. We have the ability to be aware of and reflect on experience itself. Consequently, we can appreciate the redness of a tomato, the woody smell of freshly brewed coffee, and the joy of a winning trade. More importantly, that appreciation extends into intersubjectivity, for example with the migration of butterflies between stomachs of lovers culminating in a shared orgasmic climax, the exhilaration shared with other fans when your favourite sports team wins the title, and the intense moods in markets. Consciousness values but is itself invaluable and precious.
I will now summarise some of the above into the MMH’s, admittedly preliminary, psychophysical principles:9
One important question in cognitive science revolves around the self. Is there a notion of self in the MMH, i.e. the market’s self? The answer is twofold. I have argued that—while investors form part of groups—ultimately Mr Market is us, leading to a shared identity. Still, at this stage we have to agree with Hayek, Sornette and others that any market self-awareness likely occurs top-down and at a macro-level that individuals cannot fully perceive. For evolutionary and other reasons it is probably better that way. We should thus think about phenomenology in terms of intersubjectivity, and all we can sense is Mr Market’s moods.
As far as prices are concerned the MMH submits that, at any point in time, they reflect an information state that is simultaneously realised materially and mentally. Apart from its quantitative characteristics (e.g. number of bits), such a state has qualities (e.g. economic meaning) to which investors, collectively in the market’s mind, have direct access. Market states, via moods, feel different and investors can make these qualitative distinctions. It is just that they have no knowledge about how they do this. This makes any theory which assumes complete knowledge, like the EMH, incomplete.
In terms of the mind’s dual-process system cognitions are formed subliminally or deliberately. They are true or false statements about the world but cannot all be proven. Moreover, whether they are subliminal or deliberate—which is another true/false statement—can only be determined outside the dual process system. For example whether a decision—regardless of whether it is produced by emotion (S1) or rationality (S2)—is correct can only be determined after the fact. In awareness they get valued phenomenally. This subjectivity is self-reflexive which, in Gödelian terms, escapes axiomatic capture.
In the external (real) economy money = attention. In the internal (mind~body) economy attention = money.
The next chapter will speculate what may happen when the message of this book is dismissed, and we do not mend our ways.
Chapter 11
On the Worst Case: Am I Breaking Down?
I do think we’re much safer and I hope that [a financial crisis] will not be in our lifetimes and I don’t believe it will be.Janet Yellen (2017)
Après moi, le deluge.King Louis XV
11.1
Introduction
Sooner or later everyone sits down to a banquet of consequences.Robert Louis Stevenson
In a way we profiled Mr Market during the previous chapters, asking some tough questions in the process as highlighted by the chapter titles. The impression we are left with is concerning. If we do not address it, his state could become worse. We know from history that economic systems can collapse, and we came close on a few recent occasions. What if this and other messages of this book are ignored, with TFTC (Too Few To Care)? What is a possible worst-case scenario of the evolution of markets in light of recent reality checks? In the spirit of the footnote in Subchapter 9.3.1—knowing that music captures our Zeitgeist and that history rhymes—this is my modest attempt to pay homage to Supertramp’s epic Fool’s Overture.
On that note, “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing”. This was the notorious comment by Chuck Prince, then CEO of Citibank, just ahead of its 2008 troubles and that of the market. These are the main characteristics of (most) financial crises:
They are seen as ‘black swans’ (e.g. Taleb, 2007) or ‘outliers’: they are rare, both in time and shape.
In their bubble build-up, they suggest ‘it’s going to be different this time’ (e.g. Reinhart and Rogoff, 2011): they are mentally projected as an imagined new reality, shaped by the financial economy, that everybody buys into with cheap money. In short, it is a bubble in false promises and misplaced trust.
They are causal via:
‘tail-wagging-the-dog’ effects, including those fuelled by self-reinforcing hedging strategies. These can have a disproportional impact on the real economy, (dualistically) varying from abandoned and derelict factories and homes to suffering by consumers and producers.
‘butterfly effects’—via derivatives in markets and contagion in minds—are non-linear and involve radical and uncertain change, both in terms of chaos and transformation. After all, a butterfly can cause a storm (chaos), yet is born from a caterpillar (transformation).
The reality checks I discussed qualify for such crises. They could have ended much worse. In fact, future reality checks are likely to get worse if economics does not change. Edward Chancellor, Jeremy Grantham, John Hussman, Sandy Nairn, and others have called the latest incarnation the “Everything Bubble” (or used similar terms) and argued that it is bursting. While I obviously have sympathy with their views, and there are some troubling signs, it is still early days. The men-of-system will undoubtedly attempt to kick the can some more. This will likely mean complete repression of discovery, as Russell Napier has argued, to the point where Mr Market ‘can’t take it’ anymore.
So, continuing to treat the Markets as these men-of-system have done over the past decades will have dire consequences. It means that the turmoil over the last few years will turn out to have been a bit of a breeze, forewarning that a perfect storm is brewing. But there is a lot of confusion about how this is going to play out, mainly due to our duality.
I submit that a bursting of such a bubble will likely (and finally) involve fiat currencies which, so far, have largely escaped the turmoil. In that case, the bursting bubble will become a flood and the core mentalities of confidence and faith that support the monetary system will flush away. Moods will drive this. They will shift and overwhelm to such an extent that they will affect physical stuff in the economic system beyond what we saw in the GFC. At the same time it will debunk the myth of the omniscient men-of-system and their mechanical worldview. At least for a long while. In short, this chapter will be about that final phase when the “Everything Bubble” bursts.
11.2
Of Wetlands and Debtlands
As already begun, I will continue to use metaphors and analogies to clarify the main issues. Among them are solvency and liquidity. These are terms with which we describe financial states as if everybody understands them. But because their dynamics primarily involves mind~matter exchanges, many don’t (e.g. Minsky was largely forgotten before the GFC).
Here I will focus on liquidity. Draining or increasing it—be it by printing money or by market making—has become mechanised. However, as discussed in Subchapter 6.3 for example, digitisation—as the climax of mechanisation—can have detrimental impacts when money is nothing-but digits and capital can flow in and out with a few automated clicks. Mechanisation has artificially changed the mind~matter balance of the economic system thereby interfering with its spontaneous self-organisation. It increases the potential impact (and thus relevance) of mood even more. Be careful what you wish for, men-of-system.
For inspiration on liquidity and other issues we are going to look at nature, specifically climate change which has become so clearly manifested in our weather over the past few years. Consequently, analogies with water and man-made impacts on the environment inform my story. In short, by comparing Mother Nature to human nature I will tell a tale about wetlands, debtlands, and caterpillars.
Normally, nature determines the boundaries between land and sea. Dunes, riverbeds, and cliffs are examples of natural boundaries. But we humans have not always been content with nature’s laws and decided to move the boundaries or create our own. A case in point: The Netherlands, where I was born, is a country of canals, rivers and wetlands. A significant part is below sea level, exemplified by polders. We reclaimed much of our land from the sea and then had to build protection by way of dikes and dams. Although they were aware of the risk, the Dutch intentionally moved to the polders and built their homes ‘under the water’. Specifically, they trusted the dikes, believed in their design, and had faith in the engineers who built and maintained them.
This episode has a rich but also tragic history, made famous by the story of Hans Brinker (Figure 11.1), the boy who plugs a hole in a leaking dike with his finger while yelling for help.
Source: By Uberprutser—Own work, CC BY-SA 3.0, https://commons.wikimedia.org/w/index.php?curid=33780559
Figure 11.1: Statue of Hans Brinker in Harlingen.1
But why was he sounding the alarm? Well, once water starts to seep through a dike it eats away at the fundamentals, the sand and stones that make up the dike. Moreover, one hole is a warning for the dreaded drip effect, suggesting that there are likely others in the making. Once they connect, the structure of the dike is compromised. This risks a devastating flood and Hans was doing his part in ‘saving’ his community.
Something similar is happening in the economic landscape. Normally, the real economy occupies the land with physical ‘stuff’ and other fundamentals. Capital, primarily in the form of money, streams in the rivers and seas of the financial economy, to evaporate and rain down again for growth on fertile lands. Savings and loans, credits and debits, all meet and flow together, like sweet and salt water. Crucially, the majority of the population wants capital to flow appropriately and freely and to fairly benefit all parties. Finally, like water, being liquid is one of capital’s prime properties.
However, a fast-growing region in the global economy has become a cause of concern. These debtlands are like polders where savers and spenders seemingly go about their lives and businesses. But theirs is not a natural ‘business as usual’. It has been artificially created, claimed and maintained. Whatever inhabitants of the debtlands own (a home, a car, a degree, a pension, or an oil-well), it is often structurally ‘under water’. It is safeguarded by monetary dikes and sustained by other ‘waterworks’ like monetary canals, plumbing, and sluices. These form the institutional rules and infrastructure that support the modern monetary system at the centre of which is money creation via fractional reserve banking.2 As we saw, modern money is immaterial and involves fiat currencies. Consequently, monetary dikes are ultimately made up of non-physical constructs which are designed and manufactured by financial engineering. The latter is informed by mechanical economics and delegated to men-of-system. Their designs and constructions ultimately depend on legitimacy, credibility, and trust. Overall, this makes the dikes more like ‘halls of mirrors’. Any cracks are warnings, and any holes need plugging (e.g. by the savers.)
Crucially, in terms of how mood affects the economic landscape, please think along the lines of how nature’s elusive forces—via gravity, the seasons, the weather—move land and water. As a consequence, prices fluctuate, making capital (in markets) rise and fall. Financial ripples, waves and tides are formed. Specifically, mood accompanies booms and busts. Booms experience high tides that can eventually burst, flooding the landscape with deflation and default. In such instances they turn into busts which equate to low tides or even droughts. This is what monetary dikes are supposed to protect against, according to its engineers. However, whereas engineering Mother Nature is clearly challenging, it is dangerous and ultimately futile in the case of human nature. The butterfly effect, which culminates in a hurricane, applies to mood in that it is sensitive to small initial disturbances that can turn it into an overwhelming force.
Artificially creating land is a fight against nature and its laws. Similarly, artificially creating wealth (the wealth effect) is a fight against economic laws which, in turn, supervene on psychophysical laws. That fight may be ‘politically correct’, but it is not sustainable. It is more than ironic that this was acknowledged by Summers: “there are economic laws like there are physical laws and, as with physical laws, economic laws do not yield to political will” (2015). Still, that hasn’t stopped politicians from trying. In Europe, that means maintaining the union at any cost. In the US it means maintaining superpower status at any cost. And in China it means maintaining party rule at any cost. However, they all have something in common. Not only do they need to keep the debtlanders happy, including newly recruited inhabitants. They also need their support to help maintain the landscape, including plugging holes. They achieve this via ‘politically correct’ fiscal and monetary policies, for example aimed at channelling capital into centrally planned directions (e.g. mortgages) while offering insurance (e.g. central bank put) against damages.
Enter climate change.3 Climate change reflects unintended consequences of man-made policies. The main result is a general rise in sea levels, among others putting pressure on the dikes. In the debtlands’ case, man-made policies4 vary from zero/negative interest rates (ZIRP/NIRP) and quantitative easing (QE), to currency interventions and biased regulations. Unintended consequences include leveraged misallocation (e.g. debt-funded buybacks), moral hazard (e.g. bailouts), and uneven playing fields (e.g. high-frequency trading). The pressure is in the form of financial imbalances and instability.
Under fiat conditions it is crucial that the dikes are perceived to be safe and, at least as importantly, that the financial engineers of the dikes are perceived to be in control. So, we need to look for holes in the dikes as warnings that this is an illusion and that we face the risk of a proper flood. That is, a mass panic. Arguably, holes have appeared, and we already need a growing number of fingers to plug them:
Inflation; regardless of the level (which recently set multi-decade records in many countries), generally the world experiences the wrong type of inflation, namely under conditions of debt-fuelled growth. This risks stagflation (lite).
Markets; renewed stress in credit, repo and energy markets.
Citizens; populism, strikes, and civil disobedience/protests reflecting dissatisfaction and changing mood. Remember, men-of-system need their tax payments.
As indicated, we should particularly watch currencies. While there were several incidents over the past few years (e.g. euro, Swiss franc, and Turkish lira) it was relatively contained.
Still, there are other structural issues. Despite the reality of privatised profits and socialised losses, the economic predicament is projected as ‘we are all in this together’. We might call it our Keynesian inspired variation of the Dutch polder model, a socialist consensus framework for governance. One of its pillars is the belief that all liabilities are assets, justifying the ‘creative accounting’ routine to turn liabilities into assets. The engineering part consists of securitisation that turns loans into securities for investors, as well as central banks. Buying by the latter occurs, for example, via QE whereby a central bank expands its balance sheet by buying bonds as assets. In our analogy we could call them ‘under-water’ land claims. But not all structures are built equally in the debtlands, with those at the periphery mostly at risk. Also, anecdotally we know that recently popular items are of questionable quality and would not stand a chance against a flood. Examples include PIKs, subprime car loans and low-covenant loans. Still, central banks have moved down the credit rating ladder and have increasingly been buying higher-risk debt over the past years. The need to keep pension funds above water is where the role of central bank engineering is most prevalent in our polder model.
