The Handicap Principle
A DR Classique, originally aired December 27, 2001
"Why do humans and animals alike do such dumb stuff? Stuff that is unnecessary, flamboyant, and often downright deadly?
– Richard Conniff , Discover Magazine
"I don’t want to buy ‘Diversity’," said Elizabeth. "I’ll buy ‘Ingenuity’ instead."
"Oh no…I’m stuck in a traffic jam," said Edward. "But I like jam."
"It’s not that kind of jam, you moron," said his older brother Jules, who turned 14 on Christmas Day.
The game, called "America!", entertained the family while I read Dr. Kurt Richebacher’s latest letter and other financial news.
It was just a game, of course. And a silly one. Still, each of the players wanted to win. And the way to win was simple – to get the most money. So eager was Edward to come out on top that his little hand slipped down towards the "bank" when his mother wasn’t looking.
Why do people spend so much effort on something that doesn’t really matter, I wondered? They play games as if their lives depended on them. If the theory of evolution is correct, it doesn’t make sense that people should devote precious energy to things that give them no survival edge. At the margin, the animal that wastes his time playing games should die, while the one who busies himself storing nuts and grains should survive and reproduce.
And yet, most of what people do seems to have little or no evolutionary benefit. After basic needs are met, men spend almost all their time, effort and money trying to impress other men…or trying to feel superior to them. That is what is so nice about a place like Baltimore, after all; there are so many men there to whom it is easy to feel superior.
But why would a man spend millions on an apartment on Avenue Foch when he could spend just a couple hundred thousand for one, just as big, just as comfortable, just as convenient, on the rue Mouffetard? It probably makes no difference, since in today’s world, a man with an apartment on rue Mouffetard is probably just as likely to survive and reproduce as one with digs on the Avenue Foch. But how did the instinct to this kind of conspicuous consumption ever get started?
Surely, at some dark and distant point in humanity’s past, there were men who spent all their time hunting and gathering…and others who spent some time making ornate headbands or other prehistoric equivalents of a Louis Vuitton handbag. Why didn’t the genes of the headband maker die out…since they were less likely to survive a famine?
No sooner had I posed the question than an answer presented itself. There, in my pile of reading material, beneath Grant’s Interest Rate Observer and on top of Doug Casey’s International Speculator, was an article from Discover magazine entitled "Why We Take Risks."
Buying a Louis Vuitton bag, I remind readers, is risky. In nature, everything happens at the margin. At least in theory, the money lavished on extravagance might someday be needed for food. So, too, might the calories used up in a tribal dance someday be needed for survival. Yet, everywhere you look, some common instinct tells people to boogie and buy…even when, at that very moment, they may be in danger of losing their jobs.
"Grandstanding is common in the natural world too," writes Richard Conniff, "For instance, antelope pursued by hungry cheetahs often leap acrobatically straight into the air, a practice called stotting. Common sense says they should be springing straight for the far horizon."
Common sense tells men to avoid buying stocks at 30 times earnings…and eschew unnecessary consumer spending. (Who knows, some day you may need the money for something important.) But nearly everywhere and all the time, men seem to prefer to buy both their investments and their consumer items when they can get less of them for their money. When investments are cheap, hardly anyone wants to hear of them. But when they are expensive, such as at the crest of a bubble market, they become the dearest subject of conversation among the most beautiful people in the chicest quartiers of the city. Likewise, women will want to show off the new hat they bought from Franck et Fils for $200….but rush upstairs to change when company comes rather than show themselves in the serviceable threads they bought from Sears.
"Down in the Riviera," Bernard Vuitton explained, "people try to see who can come into port with the biggest yacht. You know, they change hands all the time. Paul Allen has one of them one year…then he sells it to Kashoggi…who then sells it to someone else."
Owning a big yacht is, of course, ridiculously expensive. So the idea is to own it for just long enough to show it off to your friends…then get rid of it as soon as you can.
"A friend of mine has a yacht so big that he couldn’t get into port at all. It was too big. He had to buy a smaller boat to come into the harbor. His yacht was so big people thought it was a cruise ship. He’s still trying to sell it, I think."
But why do we stot?
"These behaviors are how we advertise how prosperous, how fit, how fearless we are," explains Conniff. "And because the world is a jaded, cynical place, we have to incorporate a significant cost, or handicap, in our advertising to make it persuasive. Thus antelopes really are indulging in a dangerous waste of energy when they stot in front of a cheetah. But their willingness to risk it is how they tell the cheetah: ‘Don’t even bother trying.’" Recent research suggests that stotting actually does seem to give the antelopes an evolutionary advantage: antelope that stot get eaten less often than the non-stotting ones.
The "Handicap Principle" is the invention of Israeli biologist Amotz Zahavi. Why do male birds of many different species have such bright, heavy plumage, he wondered. The extra feathers make the birds more vulnerable to predators. Why do men prefer women with large breasts – when smaller ones are more efficient? Why do many animals show themselves to predators…and even taunt them? Why do Irish elk have antlers with a 12-foot span?
The simple answer to all these questions: they give themselves a handicap to prove that they are superior.
But why prove they are superior?
To encourage the opposite sex to accept them as mating partners.
The ‘handicap principle’ also explains why people make ostentatious gifts – such as Ted Turner’s $1 billion pledge to the U.N. or Bill Gates’ $23 billion to his foundation. In theory, they demonstrate how rich and superior the donors are.
But theory often diverges from practice, as we often observe in these letters. The trouble with doing something stupid to impress other people is that that they might be impressed by how stupid you really are. The handicap you give yourself may backfire; you may be regarded as severely handicapped. Thus, buying stocks at 30 times earnings may not be a sign of fitness…but mental infirmity. And Ted Turner’s gift, in our view, hardly designates him as a good breeding partner. Instead, it suggests such a severe handicap that he should be a prime candidate for forced sterilization.
Likewise, we caution readers in search of mates: the richly-plumed pheasant makes as good a meal as the drab one. And he’s easier to shoot.
Your stotting editor…severely handicapped.
August 22, 2002
P.S. The ‘America!" game ended in a showdown.
"How come Edward has all this money?" Jules asked suspiciously, counting the bills. "He was losing almost the whole time."
"He must have been cheating," concluded Maria. "Edward, were you cheating?"
"Yes," Edward confessed. "But not very much."
It would be nice if the stock market rationally sorted out the good from the bad from the ugly.
But that is not the way of the world. Investors live with constant error…carried this way and that by great shifts in collective mood. For years, the public is confident, expansive, forward-looking.
And then, the tide changes direction…the public mood reverses…and people become fearful, resentful, careful.
As moods shifts, the crowd needs to find ways to validate what it feels. It needs to invent an objective reality that corresponds to its own fantasies…and eventually, come up with a way to destroy itself (but that is a story for another day…!)
It is the mood that drive the market. But what drives the mood?
We don’t know. But as the public’s mood changes, so does the news.
The U.S. is heading for its worst deficit in 6 years, reports the Financial Times.
Sales fell in July, says Reuters. Was it the heat that killed the public’s desire to spend money it didn’t have on things it didn’t need, asks MONEY.
"Credit Stress Hits Depression Level" notices the Denver Post. U.S. corporate debt nearly doubled in the last five year, to $3.9 trillion, or an amount equal to total consumer spending in 2001. Now, they’re having trouble paying. Bankruptcies are running at twice the rate of last year – which was itself a record year.
"We’re looking at an economic heart attack," the Post quoted one broker.
"It’s a bunch of dominoes that could collapse," said another. "All that money has to be paid back."
Paying off debt is deflationary and recessionary… because it takes money out of the consumer economy. Sales fall. Profits fall. Employment falls. Prices fall.
Clothing prices are at a 4-year low. Wholesale prices are falling across the board.
"The key to a depression is deflation," Ned Davis told Barron’s. "The psychology that sets in becomes one of putting off spending because prices are only going lower and paying back debt becomes extremely painful. Real interest rates soar even though they are low on a nominal basis. Deflationary accidents are associated with every depression."
Deflation is the Fed’s nightmare. It is what haunts Greenspan’s sleep. Everything has been done to prevent it. But, the error has already been made – Greenspan allowed a bubble economy…the worst bubble in history. Now, by accident, the truth is coming out… debts that were run up in Greenspan’s bubble now have to paid.
"Mortgage rates have come down dramatically," Davis continues, "and that’s allowed people to refinance and stay liquid. We’ve had huge tax cuts. We’ve had much lower interest rates from the Fed. On top of that, the automobile companies came in and offered zero percent loans. So the ability to service the debt looks pretty good now. But this cycle took the savings rate down to something we’ve never seen. Household debt to GDP was about 72%; now it’s 79%. Debt has continued to skyrocket during this bear market…"
And what has the bear market done to the debt?
"The debt is still here," Davis concludes, "but the collateral is gone."
"If there ever was a time to panic," adds the Mogambo Guru, "it is probably right around here someplace."
Eric is on vacation in New Hampshire. Addison is lost somewhere in the New World. Your editor is lost in the old one, somewhere deep in the heart of the Bordeaux wine country…very deep…
But Becky Kramer is on the job in the Paris office…bringing us the latest numbers and news:
Becky Kramer, reporting from the Daily Reckoning worldwide headquarters:
– The net result of an erratic day on Wall Street yesterday was positive, as the Nasdaq closed above 1,400 for the first time since early July and the Dow Jones jumped 85 points to 8,957.
– Leading the way on the Dow were AT&T, Home Depot, Alcoa, and Citigroup. Intel helped boost the Nasdaq 32 points to 1,409.
– Analysts certainly seem to see this one day upswing as a sign of better things to come. Bryan Piskorowski of Prudential Securities told the FT.com, "I’d say it’s a constructive, consolidating type of market with an upward bias…all said and done, the trend is higher in the near term." Peter Cardillo, chief investment strategist with Global Partner Securities, agreed, noting that the market has managed to maintain its resiliency. "Negative news is no longer [wreaking havoc]. Sentiment seems to be turning," Cardillo told CBS Marketwatch.com.
– Fed officials apparently feel just as optimistic about the entire economy. Yesterday’s comments by various Fed presidents put in doubt hopes that interest rates would be cut next month.
– Although acknowledging that the economy has taken some hits recently – signaled by data on manufacturing, consumer confidence and the job market for July – the officials expressed their belief that the economic "recovery" would continue.
– At a speech in Wisconsin, Chicago Fed President Michael Moskow admitted, "The road to recovery is turning out to be bumpy," but noted that "once we have worked our way through the current rough patch, the long-term prospects for the U.S. economy appear to be good."
– Anthony Santomero, Philadelphia Fed President, told an audience in Pennsylvania that he believed the recovery would progress and that the fall in stock prices would not hurt household spending. "I believe the Fed’s current monetary policy stance is appropriately supportive of the recovery," he said.
– What are these guys talking about? As the Mogambo Guru puts it, "The FOMC left rates unchanged, but admitted that they have ruined the economy through their own abysmal stupidity. No, wait! What I meant to say is that they noted that conditions are tilted toward economic weakness. Well, now that I re-read those two sentences, they both say the same thing, don’t they?"
Back in Bordeaux…
*** The children have had friends and relatives visiting all summer. In fact, so many visitors were expected at the Chateau d’Ouzilly this summer than Elizabeth insisted that we get some household help. Thus did Donovan appear – a friend of a friend, a young Swiss man with an unlikely name. Donovan does the cooking with such panache that we think he should have his own TV show.
A typical episode might show Donovan swatting flies in the kitchen while the gardener comes in with a live chicken under one arm and a duck under the other.
"What do you want for dinner?" asks the gardener.
Donovan’s blond hair sticks out in various directions. He went out the night before, as he does almost every night, to the local bar. He might have slept until noon had not Edward, 8, gone over and awoken him.
Donovan squeezes the duck…which must feel, at that moment, like an Enron executive before a Congressional committee. He knows he’s going to be plucked, but still not sure when. Ashes from his cigarette fall into the soup as he wheels back around to the stove.
"Let’s have the duck."
A few seconds later, the duck is hanging from the branch of a nearby tree, its throat slit…while our gardener’s dog licks the fresh blood off the grass.
Donovan goes back to swatting flies. There are hundreds of them – attracted by the rotting fruit in the wicker basket on the kitchen table as well as the general squalor of the kitchen. Kids run in and out, often crying, sometimes bleeding.
Your editor made each of the boys a rifle – cut out of piece of wood with the bandsaw. Mock battles rage through the kitchen as if it were at Chancellorsville or Stalingrad, until one of the boys knocks over a porcelain bowl, leaving it in shards on the floor like an enemy tank after a direct hit.
"Merde!" yells Donovan…."Put***!" (Even in French, we can’t repeat his comments in the Daily Reckoning.) He picks up his meat cleaver and goes after the boys like a D.A. after a CEO, chasing them out of the kitchen. Then, he lights another cigarette and returns to stirring the soup.