The Handicap Principle

“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 was the one I mentioned yesterday, “America!” It 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.

Everybody stots.

“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.

Bill Bonner
Ouzilly, France
December 28, 2001

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.”

Everyone plays the game. Investors want to get rich in the stock market. So, corporate CEO’s try to give them the impression that their stocks will make them rich.

The Washington Post reports: “Jeff Garten, dean of the Yale School of Management, interviewed 40 of the leading corporate chief executives for a new book. He said that many had told him that while they knew the expectations about earnings growth were often unreasonable, they had no choice but to participate. The system penalized anyone who didn’t play the game.”

Where real earnings were disappointing, the CEO’s could often create them out of thin air. They developed so many accounting tricks and subterfuges that it became almost impossible to know what earnings really were. At the end of November, for example, S&P companies were reporting earnings twice what GAAP rules would allow.

But no matter how you measure it, earnings are dropping. S&P 500 earnings are down to $28 this year – from $53 a year ago. The analysts are estimating $54 in earnings next year, an increase of nearly 100%. How likely is that?

Meanwhile, stocks have recovered half the loss from the peak two years ago. With earnings falling away, investors are now paying about as much per dollar of earnings as they ever did – even at the zany zenith of the recent bubblus maximus. As reported here a few days ago, earnings have fallen to 1995 levels. That was not exactly a bad year for stocks. In fact, the bull market had been driving prices higher for 13 years already. But stocks today are twice as expensive as they were in ’95.

How likely is it that they will go much higher? We don’t know, but investors have left themselves plenty of room for disappointment.



Eric Fry in New York…

– Osama bin Laden may be looking a little wan these days (living in a cave with nothing but a video camera and a bunch of un-showered guys will do that to you), but Mr. Market has never looked better. He’s one part Sean Connery, circa 1965, and one part Joe Montana, circa 1982. He’s got all the right moves for any situation.

– The Dow advanced 43 points yesterday to 10,131, while the Nasdaq tacked on 16 to 1,976. The Dow has gained ground seven out of the last nine sessions.

– It’s possible, of course, that Mr. Market is not quite as healthy and rugged as he looks. When stocks like Daimler Chrysler rally 3%, despite the company’s admission that its operations are performing below expectation, one has to wonder if Mr. Market might be more flash than substance. Whatever the case, he enjoys the steady following breeze of easy money to speed him on his way.

– Most folks consider falling interest rates to be economically stimulating because debtors may borrow money more cheaply and – so the theory goes – spend that cheap money on goods and services. But there is a dark side to this whole rate-cutting business – the nation’s savers earn less.

– “One-year certificates of deposit (CDs) now pay an average of 2.73%, down from 5.5% a year earlier,” the Wall Street Journal reports. Such miserly yields cause the nations savers to REDUCE spending. For them, there is absolutely nothing stimulating about earning half as much interest income as you did the year before.

– Slashing interest rates, therefore, amounts to a kind of economic push-me-pull-you.

– And to judge from the whines and moans issuing from America’s savers, the rate-cutting regimen that the Fed’s Dr. Dolittle has prescribed so far might be pushing the capital formation part of economy back into recession, even as it tries to pull the capital spending part of the economy out of recession.

– “It’s not that we will be destitute,” one retiree tells the Wall Street Journal. “[Falling investment income] just means the difference between having to hunker down to survive and being able to have an enjoyable retirement.”

– This reduced-spending phenomenon seems to be spreading, and as such presents a considerable headwind to economic growth. The rediscovered ethos of thrift might negate the theory advanced by the ISI Group that inventory-rebuilding alone will produce 3% GDP growth in 2002.

– But how likely are businesses to replenish inventories if consumers aren’t buying? Already, the consumer outlook is sufficiently bleak that bad credit-card debts could reach a record 8% of all such borrowings next year, estimates Standard & Poor’s economist David Wyss.

– “It is taking extraordinary measures of near desperation to keep consumers afloat,” says Stephen S. Roach, chief economist for Morgan Stanley.

– Roach’s colleague Barton Biggs agrees and predicts that lower interest rates will fail to revive the American consumer. Biggs believes the consumer is “wounded” and will remain impaired for several years.

– “Rejuvenation takes time,” he cautions. “The bust we have had [so far] is not commensurate with the size of the boom.” Biggs’ apocalyptic ranting makes the crew here at DR seem like dyed-in-the-wool (or is that dyed- in the-leather?) bulls.

– Biggs also takes a dim view of the stock market and suspects that stocks will “retest” their September lows. “The celebration currently going on is both excessive and premature,” he scowls. “It is pure madness that the tech bubble is being inflated again…[M]edium-sized marginal technology [stocks] are selling at 8 to 10 times sales and 50 times earnings…The world economy is still deteriorating and there is no pricing power,” Biggs warns. “The equity markets haven’t got that message.”

– But some well-heeled investors apparently have. “Some of the richest U.S. executives accelerated their sales [in 2001], including the heads of three software makers,” Bloomberg News reports. Oracle Corp. CEO Larry Ellison, for example, sold $894.8 million in stock – his first sales since 1996.

– Interestingly, insider sales accelerated last week as the market moved higher. “Sales typically outpace purchases by 2-to-1,” Bloomberg News observes, “[but] in the week ended Dec. 19, there were 3.7 sales for every purchase.”


Back in Ouzilly…

*** “Mortgage Applications at Record Numbers,” says a Reuters headline. “Most job losses in years,” adds a headline in the Washington Post.

Nearly 2 million people lost their jobs in 2001. But, apparently, in the great American consumer economy of the year 2002, even people without jobs will be encouraged to buy new homes.

“Stocks rise again,” says one headline. “Earnings weaker than expected,” says another. Neither lower earnings, nor lost jobs, will stand in the way of the American Dream of getting rich in stocks, while trading up to a bigger, more luxurious home. Surely it must be dangerous to take on the expense of a new home in when jobs are getting scarce. Why do people do it? Find out below…

**** “I’ll give you $300 for Diversity…” shouted Jules

“I’ll buy the 4th of July,” said Elizabeth.

“Oh oh…an IRS audit,” said Henry, “Mom, what’s an IRS?”

As I read in front of the fire last night, the kids were playing the game…again, more below…

*** “We have other apartments. Bigger.”

That was Bernard Vuitton’s answer to my question: why do you want to sell your apartment? Bernard’s apartment is on the Avenue Foch, not far from the Etoile…looking out towards the Eiffel Tower. Here is the real estate listing as it appeared in International Living:

AVENUE FOCH – EXCEPTIONAL PENTHOUSE WITH A VIEW OVER PARIS A rare property, ready to move in, fully furnished – 260 square meter duplex penthouse apartment situated in the two last floors of a luxurious building on the sunny side of the prestigious Avenue Foch with eleven- foot high ceilings, a stone stairway with wrought-iron banister, two or three bedrooms with white marble fireplaces, dressing room, double reception room with Louis XVI wainscoting and two fireplaces, oval-shaped dining room, fully equipped kitchen, two cellars, parking spaces, two maids’ rooms, audio system throughout and a lawn on a terrace with a breathtaking view of the most important monuments in Paris. Also includes a caretaker. EXCELLENT VALUE – $2.6 million USD for a quick deal. References required.

ALSO A FALCON 900B JET! This owner also offers to a serious party or individual his Falcon 900B jet, currently chartered by celebrities while not in use. JUST LIKE NEW. 11 pax. Asking Price $21 million USD (when new $32 million USD). Please refer to Adrian for details. References required.

If you’re interested, contact my friend Adrian Leeds to qualify for contact by the owner of these properties. Email:

*** Why would you want a luxury apartment in Paris for $.2.6 million, when a nice apartment – just as comfortable and more convenient – can be had for a fraction of the price? I resolve one of life’s enduring mysteries… below.

The Daily Reckoning