People who constantly change their minds are often thought of as flighty and inconsistent. Nassim Nicholas Taleb wants to prove that theory wrong, and show that those who start each day with a clean slate and new ideas make the most rational investors.
Modern times provide us with a depressing story. Self-contradiction is made culturally to be shameful, a matter that can prove disastrous in science. Marcel Proust’s novel In Search of Time Lost features a semiretired diplomat, Marquis de Norpois, who, like all diplomats before the advent of the fax machine, was a socialite who spent considerable time in salons. The narrator of the novel sees Monsieur de Norpois openly contradicting himself on some issue (some prewar rapprochement between France and Germany). When reminded of his previous position, Monsieur de Norpois did not seem to recall it. Proust reviles him:
"Monsieur de Norpois was not lying. He had just forgotten. One forgets rather quickly what one has not thought about with depth, what has been dictated to you by imitation, by the passions surrounding you. These change, and with them so do your memories. Even more than diplomats, politicians do not remember opinions they had at some point in their lives and their fibbings are more attributable to an excess of ambition than a lack of memory."
Monsieur de Norpois is made to be ashamed of the fact that he expressed a different opinion. Proust did not consider that the diplomat might have changed his mind. We are supposed to be faithful to our opinions. One becomes a traitor otherwise.
Path Dependence: A Perfect Trait For a Trader
Now I hold that Monsieur de Norpois should be a trader. One of the best traders I have ever encountered in my life, Nigel Babbage, has the remarkable attribute of being completely free of any path dependence in his beliefs. He exhibits absolutely no embarrassment buying a given currency on a pure impulse, when only hours ago he might have voiced a strong opinion as to its future weakness. What changed his mind? He does not feel obligated to explain it.
The public person most visibly endowed with such a trait is George Soros. One of his strengths is that he revises his opinion rather rapidly, without the slightest embarrassment. The following anecdote illustrates Soros’ ability to reverse his opinion in a flash. The French playboy trader Jean-Manuel Rozan discusses the following episode in his autobiography (disguised as a novel in order to avoid legal bills). The protagonist (Rozan) used to play tennis in the Hamptons on Long Island with Georgi Saulos, an "older man with a funny accent," and sometimes engage in discussions about the market, not initially knowing how important and influential Saulos truly was. One weekend, Saulos exhibited in his discussion a large amount of bearishness, with a complicated series of arguments that the narrator could not follow. He was obviously short the market. A few days later, the market rallied violently, making record highs. The protagonist worried about Saulos, and asked him at their subsequent tennis encounter if he was hurt. "We made a killing," Saulos said. "I changed my mind. We covered and went very long."
It was this very trait that, a few years later, affected Rozan negatively and almost cost him a career. Soros gave Rozan in the late 1980s $20 million to speculate with (a sizeable amount at the time), which allowed him to start a trading company (I was almost dragged into it). A few days later, as Soros was visiting Paris, they discussed markets over lunch. Rozan saw Soros becoming distant. He then completely pulled the money, offering no explanation. What characterizes real speculators like Soros from the rest is that their activities are devoid of path dependence? They are totally free from their past actions. Every day is a clean slate.
Path Dependence: Are You Path Dependent?
There is a simple test to define path dependence of beliefs (economists have a manifestation of it called the endowment effect). Say you own a painting you bought for $20,000, and owing to rosy conditions in the art market, it is now worth $40,000. If you owned no painting, would you still acquire it at the current price? If you would not, then you are said to be married to your position. There is no rational reason to keep a painting you would not buy at its current market rate – only an emotional investment. Many people get married to their ideas all the way to the grave. Beliefs are said to be path dependent if the sequence of ideas is such that the first one dominates.
There are reasons to believe that, for evolutionary purposes, we may be programmed to build a loyalty to ideas in which we have invested time. Think about the consequences of being a good trader outside of the market activity, and deciding every morning at 8 a.m. whether to keep the spouse or part with him or her for a better emotional investment elsewhere. Or think of a politician who is so rational that, during a campaign, he changes his mind on a given matter because of fresh evidence and abruptly switches political parties. That would make rational investors who evaluate trades in a proper way a genetic oddity – perhaps a rare mutation. Researchers found that purely rational behavior on the part of humans can come from a defect in the amygdala that blocks the emotions of attachment, meaning that the subject is, literally, a psychopath. Could Soros have a genetic flaw that makes him rational as a decision maker?
Such trait of absence of marriage to ideas is indeed rare among humans. Just as we do with children, we support those in whom we have a heavy investment of food and time until they are able to propagate our genes, so we do with ideas. An academic who became famous for espousing an opinion is not going to voice anything that can possibly devalue his own past work and kill years of investment. People who switch parties become traitors, renegades, or, worst of all, apostates – those who abandoned their religion were punishable by death.
Nassim Nicholas Taleb
for The Daily Reckoning
February 1, 2005
Nassim Nicholas Taleb is an essayist principally concerned with the problems of uncertainty and knowledge. Taleb’s interests lie at the intersection of philosophy, mathematics, finance, literature and cognitive science, but he has stayed extremely close to the ground, thanks to an uninterrupted two-decade career as a mathematical trader. Specializing in the risks of unpredicted rare events ("black swans"), he held senior trading positions in New York and London, before founding Empirica LLC, a trading firm and risk research laboratory. Fooled by Randomness has been published in 14 languages, and the author’s ideas on skeptical empiricism have been covered by hundreds of articles around the world.
There was little financial news yesterday. Investors took it the wrong way. The longer things don’t seem to change, they tell themselves, the less likely they are to ever change. Consumers dug a little deeper – putting themselves in a deeper hole. The Chinese and Japanese may have bought a few more Treasury bonds; how they’ll ever get out of them, no one knows. Investors took in a few more shares of e-bay, Google and God-knows-what. And everybody was convinced that nothing bad would happen. In fact, they expect nothing to happen at all.
But a correction postponed is a correction aggravated. Change is one thing you can count on. Tout passe…tout casse, the French say. Everything breaks, and everything disappears. From fragile buttercups…to giant oaks. From refrigerators to love affairs.
Change comes in fits of temper. And after a period of stability and contentment, people begin to think that change is a thing of the past. They have fallen in love; it will last forever, won’t it? They begin to think they’ve reached the "end of history."
American-style democracy is so near perfect, no finer system can be imagined. History, seen through the blurry, besotted eyes of American voters, has been nothing other than a march towards Washington. And now that we are here…now that we have arrived with the neo-cons on the banks of the Potomac…there is nowhere else to go.
Could other people in other countries be evolving even more perfect unions – political systems better suited to their own vices? No, we look in the mirror and see the most attractive face on earth, one that grows better looking every day. Of course the rest of the world loves us and yearns to be like us! And if they don’t seem to want to be like us…it is only because they are stupid and evil…so we will force them to be like us, and then…won’t they be happy! If we can just get everyone to stand in line to vote, like we do, the whole Middle East will be safer, richer and more peace-loving, say the world improvers.
One day, historians will look back at our era and wonder why Bush and Blair were so determined to convert the Iraqis to democracy. To our descendants, it will look like a mad caprice…or a quaint, religious gesture – an act of remarkable faith or delusion, like missionaries showing the heathen the correct posture for copulation. Even now, we can’t quite remember why we are there. In the future, it will probably seem loony and incomprehensible.
America’s consumer economy, too, will be bankrupt and discredited. Economic historians will marvel at how so many people who had taken Econ 101 could have been so naïve, so credulous and so stupid. How could they believe that they could live off foreigners for so long? How did they think they could prosper without savings? Why did they think they could live beyond their means forever? Perhaps they will look back at George W. Bush’s State of the Union Address, scheduled for tomorrow, and gape at how a nation that couldn’t save a dime thought it could save the entire world.
We hope that at least some future historians see the humor in it. And maybe one or two will take notice of the elegant perversity of history itself: The more comfortable people become with their politics and their economy, the surer they are to make a mess of it.
Were Americans less proud of their own system…and less arrogant about its virtues…they wouldn’t be spending $200 billion that they don’t have trying to foist it on the rest of the world.
And were Americans a little more suspicious of the Greenspan Fed, speculation in housing, unlimited debt finance and the other wonders of the consumer credit economy…they wouldn’t be so ready to spend themselves into the poorhouse.
Thus it is that change arrives – when least expected and least welcome. It storms in like a jealous husband, waving a gun. Watch out, dear reader… watch out.
More news, from our team at The Rude Awakening:
Eric Fry, reporting from Wall Street…
Bill Bonner, back in London:
*** If we have a global boom, which countries are likely to benefit the most? The fast-moving Asian countries, says Marc Faber in Barron’s. If we have a global bust, which companies are likely to get hurt the least? The low-priced Asian producers, he continues. Asian companies are selling for prices that are lower than they were in 1990. If the Dow were back to 1990 levels, it would be priced below 2400.
Buy land in India, Faber concludes.
Or how about a hospital management company in Thailand that yields 5%? Try Bangkok Dusit Medical Services.
*** We hear bells ringing.
First, our oldest son called from Florida. Could we lend him some money so he could buy a house not far from the inter-coastal canal, he wanted to know. Prices are soaring…he is sure he’ll make a killing. He can’t imagine that prices can go down – they’ve gone nowhere but up since he was born.
Second, from the Christian Science Monitor comes news that real estate is "one of the hottest curriculums on college campuses." NYU is said to have 5,000 people signed up for its Real Estate Institute. Signs of a bubble in real estate keep
Third, the insiders are selling. Barron’s reports that the CEO of Lennar, one of the largest homebuilders in the nation, just sold a big slug of shares – pocketing more than $5 million. He may have sold the shares because he is sending his boy to NYU’s Real Estate Institute. Or maybe his son asked for a loan. But he’s not selling them because he thinks they’re going up.
Marc Faber also considers the homebuilders a "sell."
*** Wanna buy something that will go up? Buy gold…or Newmont Mining. When change does come breaking down the door…people will want gold to protect themselves. Oil would be a good by too – maybe not this year, but sometime soon. The world is set up to use cheap oil. But the cheap oil has nearly all been pumped already. Oil should hit $100 a barrel before the end of this decade. And what else? Oh yes…food! In the last 20 years, world grain production rose only 25%, but as people – particularly in Asia – grow richer, they want to eat more meat. And you can’t produce more meat without a lot more grain. Inventories peaked out 18 years ago and are now less than half the level of 1987. And nearly all the grains are selling at very low prices – 20-year lows, in fact.
*** Another long-suffering correspondent:
"Gold has its virtues and fiat money its dangers. But your argument is a tad simplistic.
"Since at least the 1920’s our economy has been driven by consumption, and to use the supply of any substance, gold included, as an artificial constraint on productive capacity is an act of sheer lunacy in a consumption driven society.
"It is much like the battle of Isandlwana Mountain in the Anglo-Zulu war. Legend has it that the quartermasters for the right and left sides of the battle line had ended up on the left and right sides of that same battle line. Rather than issue ammunition to the troops near them, the
quartermasters insisted on having the ammunition passed the length of the battle line to their own troops. This slowed down the receipt of ammunition and diverted the attention of soldiers being massacred to unnecessary transportation issues. The troops were killed almost to a man, but at least the quartermasters would have been able to account for their distribution of ammunition according to the most stringent army standards – if any of them had survived!
"Now a consumption driven society at this point in history probably represents lunacy itself, but artificial restrictions on productive capacity will not get rid of this lunacy. They will simply result in widespread
poverty and wars."
We offer a note of clarification. We do not propose gold backing as a solution to the world’s many money issues. We only propose it as a solution to OUR OWN money issues. In other words, we see no reason why the world should go to war simply because we have stashed a few gold louis in our backyard.
*** More reader mail:
"I personally think that McDonald’s should counter sue the children’s parents for negligence. They neglected as their parental duty to ensure that their children grew up healthy. Due to their laziness, they failed to provide healthy, nutritious food, so instead of taking the time to shop for and prepare wholesome dishes, they took the easy way out by piling their children in the car and pulling up to the drive-thru or bellying up to the counter to order a few Big Macs. As a former food service industry worker and manager, I still take offense to people blaming the food. I cannot remember one instance when Ronald McDonald or the Hamburglar drug anyone into the store and force-fed him or her. I have worked for more than one restaurant chain, and no matter which one I was employed at, never has there been an instance of force-feeding any member of the public.
"When my son was a teenager and started frequenting McDonalds by himself, I reprimanded him about eating healthy, he reminded me that he had been raised to make good choices, and most of the time ordered a salad. Children will practice what you preach, as long as you practice what you preach. I personally think that if we are going to go forth with this litigious society, then the Pediatrics Association of America ought to require all pediatricians to report parents of overweight children for child abuse and neglect. I think they should be required to attend nutrition classes, and if they are overweight themselves, they should be required to lose weight as an example to their children. If they or their children fail to lose weight, they should be trotted off to fat camps at their own expense.
"How big do we want our government to be? And if I sound outraged and sarcastic, it is because I am so tired of people not wanting to be responsible for their own actions. This entitlement mentality has got to stop."