Foolish Wisdom

Last week in this space, Bill Bonner took us through the first part of the book, The Wisdom of Crowds…and in this follow-up essay, he shows us the difference between a group of people made up of individual thinkers – and a crowd of people that share one brain.

When we took our leave last week, we had just read part one of Mr. James Surowiecki’s much-discussed book, The Wisdom of Crowds. It was not as bad as we feared. Mr. Surowiecki seemed to us like a teenager who had just discovered sex. He didn’t quite know what to make of it, but he was clearly looking forward to it.

What he had stumbled upon was civilization, the infinite and subtle private arrangements that allow people to get along and make progress, without anyone in particular telling them what to do.

Alone, a man cannot really do much. He is only in his present state of comfort as a result of centuries of tugging by millions of different people. Someone had to figure out how to use fire. Someone realized that you could burn oil. Someone else had to discover iron. Someone, somehow, sometime put the pieces together…and millions of others…to manufacture the modern automobile. Even with access to all the accumulated knowledge of 100 generations, a man alone could never manufacture even a single automobile. There are too many component parts involving too much local knowledge. On his own, he’d be lucky if he could fashion a crude go-kart out of soft wood.

The more elevated a man’s situation, the more he relies upon the knowledge, expertise, capital, and goodwill – not only of past generations, but of his neighbors…and many people he has never met. That is how civilization works. Two heads are better than one.

Even – or perhaps especially – the world’s greatest and loneliest geniuses realize that their contributions rest largely on the work of others. Newton mentioned that he could only rise so high because he was “standing on the shoulders of giants.” Science is cumulative and universal. Newton could draw on work done by foreigners hundreds of years ago. But he used is famous phrase in a letter to a rival, Robert Hooke, who was a dwarf. Science may have marched forward, but Newton’s heart was as mischievous – or perhaps as cruel – as any since the Flood.

Mr. Surowiecki seems only dimly aware of what goes on in the human heart. Again, he is like a teenager who just discovered sex. He is so fascinated by the mechanics of it, he has not yet thought about the perverse and cynical possibilities. Yes, groups of people can solve problems. Yes, groups of people can come up with good ideas. Yes, groups of people – drawing on diverse information and insights – can create things that no individual alone could possibly imagine.

And yes, as the author allows, sometimes groups get things wrong. They are often bullied by a single person. They tend to think alike. They are easily distracted. But when people can work together – with no one holding a gun to their head – people have a way of getting along and accomplishing things.

The Wisdom of Crowds: Groups Are Not Crowds; Crowds Are Not Mobs

But a group of people working together is not the same as a crowd. And a crowd is not the same as a mob.

A group is merely an aggregation of individuals, each with his own independent opinions and information. A group is also a collection of private individuals, each with his own private goals.

A crowd, on the other hand, comes together and begins to act as one – and soon makes a public spectacle of itself. An army, for example, is a crowd. It acts with one mind. One emotion. For one purpose. In an army, independent thought is discouraged. Deserters are shot. As we have pointed out often, you wouldn’t want to go into battle with a free-spirited intellectual at your back; you want a real blockhead with a singleminded goal: to kill the enemy and protect you.

The biggest fear of military leaders is that their army will cease to be a disciplined crowd…and turn into a mob. It will still act as one – with one over-reaching emotion firing up every grunt’s heart – but the emotion is likely to be fear…that will destroy the effectiveness of the fighting group.

Groups of investors sometimes turn into crowds. They do so when they all stop thinking independently, and begin to act as one. The crowd may be moved by fear or greed. In either case, it is likely to overreact to news…and overprice its favorite investments.

Mr. Surowiecki notices all these things, more or less. He notes that neither voters nor investors are exactly the rational creatures of academic imagination. He realizes that they are, from time to time, led astray by various influences. Yet, somehow, he fails to notice the key feature of the ‘crowd’ that separates a healthy, efficient group from a great mob ready to get itself into trouble. Once again, like his New Yorker feature on gold, he has managed to write something that is wise and moronic at the same time. It is wise to notice that two heads are sometimes better than one. It is moronic to fail to notice why.

The Wisdom of Crowds: The Hazards of Crowds

Yesterday marked the 60th anniversary of the liberation of Auschwitz. The extermination of the Polish Jews was something that no man could have accomplished on his own. It took the cooperation of thousands – no, probably millions – of people to make it work. Administrators had to do the paperwork. Policemen and soldiers had to round up the victims. Rail workers had to get them to their destination. The prisoners had to be fed (minimally) and housed (badly) before they could be exterminated. Then, the bodies had to be disposed of. This, too, was a remarkable engineering problem…requiring the efforts of hundreds or thousands of people… These people who had to stand on the shoulders of many generations of engineers before them…so they could push a few generations of Jews into open trenches…or burn them in open-air furnaces.

Where was the wisdom of the crowd? Surowiecki doesn’t bother to raise the question. Perhaps there was not enough “diversity” in the Nazi ranks, he might suggest. Maybe, the Nazi leadership was not open enough to different points of view, he might say. The Nazis were not “independent” enough, he might add; nor were they allowed to express their “private judgment.”

All of these things may be true. But who was going to stop a top SS meeting and suggest that they bring in a gay gypsy or Bantu democrat to give an alternative point of view? Who among them doubted that they did not already have all the judgment, opinions and information they needed?

Likewise, at the peak of the bubble market in tech stocks at the end of the ’90s, what investor who had made a fortune on Microsoft and Amazon wondered if needed more diversity in his portfolio?

When the crowd takes up a corrupt wish – to get something for nothing…or to make the world a better place by killing people – the last thing it wants is another point of view. It is already too late for that. The few people who are able to think clearly can only try to get out of the way. If they are in a bubble market – they can easily sell. If they are in a country that has lost its head, they can try to leave. If they are in an army, there is not much they can do at all.

And so we come to the end of Surowiecki’s little book and we realize that he missed the whole point. He is still gazing at the sex act as if watching a porno movie. It is engaging, of course, but there’s more to it.

Had he merely thought a little harder, he might have found something important: What he is describing as “wise crowds”is really the fluid, unfettered interactions between individuals in a civilized society. In many cities, for example, people drive around with hardly a traffic light or traffic cop anywhere. Yet, most get where they are going without accident. Groups of people – aggregating individual strengths, compensating for individual weakness, composing individuals’ knowledge – have always been successful. That is how primitive groups hunted animals larger and fiercer than any one of the hunters. This kind of cooperation is the foundation of civilization, the division of labor, and the accumulation of expertise and knowledge.

Of course, crowds are going to go wrong from time to time. Human nature has not changed. Crowds can be swayed by skilled orators, the popular press and false signals from central bankers. Half-wit mobs can be turned violent by a journeyman demogogue. But where the crowd really goes wrong is where it turns from cooperation to force…when it begins to insist…and build concentration camps. This is where it becomes uncivilized.

Democracy, says Surowiecki, demonstrates the wisdom of the crowd. And yet, it seems to demonstrate the exact opposite. Voters have no independent information. They have no way to make independent judgments. They are easily swayed by the press and rabble-rousing politicians. They are a crowd – not a group of aggregated individuals – from the very beginning. They pass judgment on people they have never met and ideas they can’t understand, eventually taking money that doesn’t belong to them…and spending it on things that are usually disastrous. Democracy replaces cooperation with force…consensual civilization with the tyranny of the majority…the wise crowd of independent citizens with a mob of voters, with silly slogans on their bumpers and mischief in their hearts.


Bill Bonner
The Daily Reckoning

January 28, 2005 — Paris, France

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).

The World Series of Humbug continues as the blabberfest in Davos, Switzerland begins another day.

Newspapers dutifully report the latest bamboozle. More aid for Africa! Stop climate change! A new solution for Palestine!

But can you really fault these idealists? Sure, much of what they propose is hopelessly unrealistic…or downright fraudulent. But don’t we have to at least try to do something to improve the planet?

We take the questions one at a time: Yes and no.

One by one, the world’s leaders rise. Solemnly, sincerely, they call for absurd measures – every one of which involves grand larceny. A few billion for this project…a few more billion for another. And not a penny of it out of the pockets of the great and good who, when not pompously grandstanding, are enjoying the caviar and champagne at Davos – usually, at someone else’s expense. With a few notable exceptions, such as Bill Gates, none of those present has ever done anything but make the planet worse. They call for an end to world hunger – but none has planted a single turnip. They want to raise the Africans out of poverty – but who among them has started a business or built a bridge on that Dark Continent? They say they are for peace, but nearly everyone proposes some form of meddling in the affairs of others – almost sure to provoke an outbreak of violence at some point.

No, dear reader, these people are not doing good. They are doing very well – for themselves.

But, our beat is money; we have to keep reminding ourselves. And yesterday, the world of money seemed to stand still

The dollar is holding at $1.30 per euro.

The Dow is holding around 10,400.

Gold is holding near $425.

Meanwhile, the United States is holding its course to financial doom. And U.S. consumers are holding the bag! The U.S. lumpen householder has put himself deep in debt in order to keep America’s fantasy economy rolling along. At some point, of course, the bubble will burst and the poor schmucks will have hell to pay. We keep wondering when that day will come.

The big news out of Davos was the speech we reported yesterday – Chinese economist Fan Gang told the world that the dollar’s days are numbers. The greenback won’t stop “devaluating,” he said. So, China will look elsewhere to place its reserves.

America desperately needs China’s cooperation. U.S. current account deficit is at a record high of about $650 billion; that is, it is greater than it was before the dollar fell. And the U.S. federal deficit is on course for a new record too – at about $427 billion for this year. And according to most recent reports, 83% of this shortfall is financed by foreign central banks. The overseas banks already hold more than $1 trillion of U.S. Treasury debt, $906 billion of which is just two places – Tokyo and Beijing.

There is a limit, said Alan Greenspan a few months ago, “to the willingness of foreign governments to finance U.S. current account deficits.” Fan Gang seemed to be saying that the limit had been reached.

More news, from our team at The Rude Awakening:


Eric Fry, reporting from Wall Street:

“‘Dumb money’ takes many forms, but its underlying nature rarely changes. It never becomes ‘smart money,’ for example, though it make masquerade as such for a while.”


Bill Bonner, back in Paris…

*** “The real problem with the U.S. economy,” writes Edward Hadas, “is not that it isn’t competitive with Asia.” After all, who can compete with labor rates of 21 cents an hour? But America is not competitive with Europe either – even though costs in Europe are even higher than they are in the United States.

“The clearest evidence of the U.S. industrial decline is the country’s trade with the EU. That is probably the fairest economic contest around. Hourly labor costs in the EU are higher than in the United States and the currency markets are quite free. The U.S. is clearly losing this trade battle. In euro terms, its trade deficit with the EU had grown by 50% since 2000, including 4% last year. A 40% dollar devaluation over the period has not had any clear effect.”

The EU gained ground without the slightest help from its central bankers. Kurt Richebacher explains:

“During the past few years, there has not been the slightest effort in Europe to stimulate the economy with artificially low interest rates because we don’t believe in this. It’s not because we are stupid, but because we don’t believe in it.

“Meanwhile, the Federal Reserve has boosted its deficit over this time by 7% of GDP. In Europe the deficit today is the same as five years ago.”

Americans cut rates to increase consumption. In the span of four years, 2000-2004, consumption increased more than 100% of GDP growth. They actually consumed more than they made, with the extra consumption coming from imports. If you consume more than you produce, you have nothing left over to build factories, develop infrastructure improvements and make the kind of investments that lead to higher wages and real economic growth. Not surprisingly, real wages fell in 2004. Americans grow poorer.

Don’t miss The Great Profit Debate at the World Money Show in Orlando, Fl, next Thursday. Investment heavy-hitters Dan Denning and James Boric are going to duke it out live. Denning is a big-picture macro-guy who plays options on ETFs. James, an inveterate small cap sleuth, could care less…he’s buying great companies cheap on their fundamentals – and watching them skyrocket in value.

“The Great Profit Debate” will be moderated by New York Times best-selling author (and Editor-in-Chief of The Daily Reckoning)Addison Wiggin. Stuck in the middle, will be value seeker Chris Mayer, editor of the Fleet Street Letter. Chris has his own approach, which he calls: “Tangible Assets That Sweat.” Chris does just fine in any market.

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