Tit For Tat

The man who touched off World War I, by sending the Archduke Ferdinand to his eternal rest, was described as an “anarchist.”

Anarchists are back in the news – rising up to protest the World Bank, the IMF, the Republicans and Democrats, the pasteurization of milk and the division of labor. They are gathering now in Los Angeles, the Post warns, to make their voices heard at the Democrats quadrennial bombast – the national convention.

I admit to being soft on anarchism. The creed has much appeal. You don’t get jury duty. Nor are you called upon to make campaign contributions. Your sentences don’t have to make sense. And I like black.

But the ‘anarchists’ in the Post article give followers a bad name. As Ray DeVoe says, they are ‘rebels without a clue.’ The poor saps don’t understand anarchism, but even less the many things they are protesting. Instead of eliminating government, they want more of it…more controls over this or that…more people with the power to tell you what you can do and what you can’t. Compared to one of these people, even a Democrat seems harmless.

Without government, it is widely believed, the strong would exploit the weak…the rich would exploit the poor…the capitalists would exploit the workers…and people would drive on the wrong side of the road, if there were roads.

The assumption underlying modern politics is the same one that supports economics – that man acts in his own self- interest, rationally, and usually, ruthlessly.

Rational self-interest is said to guide decision-making. People figure out how they can get the most for themselves. They think about their families too, the theory goes, but only because they share so much genetic material.

Rational self-interest is at the heart of the ‘prisoner’s dilemma’ I mentioned yesterday. There, too, is the central banker’s and politician’s dilemma – which dooms paper money, including the dollar.

A man, looking out for #1, will do things that benefit him – even if they are harmful to the rest of society: Grand Theft Auto, inflation of the currency, murder, rape, betray his partners and his wife – you name it.

Against these abuses, this supposed anarchy, stands the government – ready to protect, defend, and sort out the conflicting self-interests of its citizens.

The only problem is that it isn’t true.

John von Neumann invented game theory, went mad, and eventually recovered. But his games allowed scientists to test people to see how rational self-interest really worked.

These games were the equivalent of putting people in a ‘prisoners dilemma’ situation to see at what point they would ‘defect’ and choose their own interests over those of the group.

Scientists played the game themselves – putting small sums of money at risk. But instead of choosing the tactics predicted by the theory of rational self- interest, they cooperated to produce the greatest good for the group of players.

These results were so at odds with the theory that the researchers refused to believe them. They argued that the players were too stupid to understand where their own interests lay.

Finally, in the 1970s, computers were brought in and taught to play the games. As Matt Ridley puts it: “Computers started using their cold, hard, rational brains to play the prisoner’s dilemma, and they began to do exactly the same thing as those foolish, na?ve human beings.”

This led to a contest. Setting up ‘prisoner dilemma’ situations, contestants were asked to devise computer programs that would play other programs to see what strategy emerged victorious. The underlying question – when does it pay to cooperate…and when does it pay to ‘defect’?

The winner was an elegantly simple program called ‘Tit for Tat,’ a computer simplification of the kind of personality that might succeed in real life. Tit for Tat won by imitating what people really do – not what the rational self-interest theorists thought they should do.

Tit for Tat is nice. It offers to cooperate. It never defects first. But it is no doormat. When another program is unkind to it – it retaliates…and then offers to resume its cooperative behavior. What’s more, Tit for Tat is clear. Other players know what it will do.

What the competition suggests is that modern economics and the rationale for government is based on a myth. Humans do not really compete selfishly. They cooperate collectively.

So strong is the desire to collaborate rather than battle it out that it proved a problem as WWI developed. Bogged down in the trenches, the soldiers on both sides began to cooperate with each other – and ignore the orders of their superiors. Informal truces were declared and respected. Rules of behavior – about when you could shell an opponent, fair warnings, and the treatment of casualties – developed. The rules were backed up, just as they were in the Tit for Tat program – by retaliation.

Usually, retaliation was followed by reconciliation. But sometimes, unscheduled battles broke out.

Eventually, generals discovered they had to put a stop to the anarchy developing in the trenches by moving troops around frequently, so they did not develop friendly ties with the enemy. This allowed the slaughter to continue as planned.

It is this drive to cooperate…and the development of trust, and rules of the road…that enables the expanding division of labor. Francis Fukuyama noticed that ‘high trust’ societies were also the richest. No wonder – they allow the division of labor to expand.

But even in high trust societies, it’s risky to leave your keys in the car…and your money in paper currency. And even the division of labor has its limits – as we will discover in tomorrow’s letter when, I promise, I will finally reveal the inner workings of marriage…and explain how Tit for Tat has a romantic side too.

Your ever-puzzled pen pal,

Bill Bonner

Paris, France August 9, 2000

** The Dow rose by 109 points yesterday. Bush seems headed for the White House. Productivity has returned to levels not seen since Austin Powers first met Dr. Evil – the swinging 60s. (That is, if you believe the Bureau of Labor Statistics.) And unit labor costs are going down…again, according to the BLS. So, unless something else happens – Greenspan is unlikely to boost rates again on the 22nd of this month.

*** What’s not to like? 1588 stocks advanced. Only 1256 fell back. 123 hit new highs – a very big number – while only 33 hit new lows.

*** “Those numbers were really positive for the market,” Reuters quotes a fund manager. He was speaking of the productivity numbers in particular. The BLS has non-farm productivity rising at the fastest rate in nearly 17 years – 5.3%.

*** A larger economy, and better communications, produce an expansion of the division of labor. A Bombay architect, who used to content himself with whatever work came his way – designing a house for a neighbor, a sunroom for a man down the street, a gas station for a commercial client – can now specialize. Working on the Internet, he may choose to design only elaborate lawn follies, decorated with the lewd and nightmarish figures of Hindu gods.

*** Applying himself singularly to the task, he is likely to be able to do more and better work than he would if he were to jump from one project to another. He may even design special tools – such as a software program – to make his work easier. Thus, productivity increases.

*** The Internet and globalization are bound to increase productivity. But it is unlikely that the BLS has been able to measure it. Nevertheless, the number the BLS came up with was much loved by Wall Street, seeming to confirm the delusions of New Era aficionados. Greenspan, so fond of words such as “innovation,” “productivity’ and “technology,” can keep mumbling. Meanwhile, the BLS admitted that it was a touch too optimistic about the figures for the first quarter – and revised its figure of 2.6% growth down to 1.9%.

*** Another figure the street liked was the price of labor, per unit of production. All the news is good news in the ‘summer of love,’ and this was no exception. It fell. Of course, once the productivity numbers had been teased out, the labor cost figure was a cinch. If output increased by more than 5% – wages could go up by the same amount before triggering an increase in unit labor costs. But if productivity did not really increase as much as advertised – the unit labor cost would look much less fetching.

*** With all this positive feeling about the U.S. market, the dollar rose. The euro fell below 91 cents. It’s still above its low point of 88 cents, reached in May, but not much.

*** This may be an historic time to leave the dollar. The euro seems too cheap. The dollar seems overbought. I feel like buying something in Europe. I noticed that another chateau – a fixer upper – is for sale in the Poitiers area. Someone, please, stop me.

*** Gold goes down as the dollar goes up. Yesterday, gold responded on cue – falling 40 cents.

*** Amazon is still struggling to stay above $30.

*** Which brings up an interesting question… if AMZN is still losing money by the end of the year can they still keep the “.com” in their domain name? After all, the designation is meant for commercial, for-profit companies.

*** Cisco reported higher-than-expected earnings. It made a profit of 16 cents a share during the latest quarter – up 32%. Hmmm… if it can keep that up it will make 64 cents for the year. Apply the rule that the P/E should be equal to the growth rate. That makes Cisco worth 64 cents x 32 = $20.48. Hmmm… that’s a bit more than the current $68 price.

*** The Financial Times reports that there is a new “hot topic” in the investment world. It’s called behavioral finance, “a theory that sweeps away the conventional thinking that investors make rational decisions.” But you already knew that.

*** Dun & Bradstreet reports that “June Insider Trades Slowed Substantially from May.” Insider additions and disposals for June slowed noticeably from the prior month. On the purchasing side, executives bought a total of over $271.6 million-worth of shares in May, compared to just $193.1 million in June.

*** “That’s a 28% drop… not a minor change,” comments Lynn Carpenter of our team. “Insider sales tend to be right, but early. The lead between insider purchases or sales and a stock movement in the same direction is around 3-6 months.”

*** IBM made 19% less money in the second quarter this year than they did in last year’s second quarter. Sales declined by 1%.

“Can you believe it,” asks our pirate investor, Porter Stansberry, “IBM is dying on the vine while all of its competitors – Sun, EMC, Network Appliances, Dell, etc. are having breakthrough quarters.”

*** The trouble at IBM, as Porter points out, is that the company has been so keen to boost ‘shareholder value’ that they have destroyed the business. Instead of investing in new plant and equipment, Big Blue bought back its own shares – at record prices – cut costs, and massaged the numbers. These practices make the shares look good in the short run. But in the long run they are a disaster.

*** I got up early this morning and caught the train at little Lathus station. As usual, I was the only one on the platform. Three hours later, I arrived in Paris. Well, it ain’t Baltimore, but then… what is?