The Psychic Prison

AlcatrazIsland_TheRock

The first self-archetype is merely the subset of James’ blooming, buzzing confusion that we classify into our mind’s “I.” It is extraordinarily hard to redraw this boundary later in life. Hallucinogenic drugs, intense stress, sensory deprivation chambers, or the rigors of meditative practice are usually required.

Venkatesh Rao, Tempo

Freedom’s just another word for nothin’ left to lose.

Kris Kristofferson, “Me And Bobby McGee”

John Patrick Mason: Your “best?!” Losers always whine about [doing their] best. Winners go home and f*** the prom queen.

The Rock (1996)

This is going to be one of those abstract, philosophical posts. Consider yourself warned. However, portions will tie in rather neatly with investing. So you may want to stick around. I’m also going to try to write with as much clarity as possible here, because the concepts I want to explore in this post are fundamentally weird. In order, they are:

  1. Identity functions as a psychic prison.
  2. To have any chance of escaping the psychic prison of identity, we must to cultivate the ability to redraw the boundaries of the self.
  3. Therefore, freedom is, at a fundamental level, the ability to participate as a principal in the process of creative destruction.

Let’s start at the beginning.

The Psychic Prison

There’s a well-known quote from the book (and movie) Fight Club: “the things you own, end up owning you.” The idea is that over time you settle into a pattern of consumption. You stagnate within this pattern. After a while, it is impossible to determine whether you define your pattern of consumption or whether your pattern of consumption defines you.

I’ll take this a step further and suggest the following: the thoughts you think, end up thinking you. That is to say, you think your “self” into existence.

We’ve all met someone who’s chronically negative. That person who’s always put upon, who’s always sick, who’s always short on cash or the victim of sinister forces outside her control. That person who spends her life lurching from one crisis to the next. At times it seems as though she’s the physical manifestation of negativity and misfortune in the world.

It seems that way because it’s true. That person truly is a physical manifestation of negativity and misfortune. While plenty of her misfortunes may well be beyond her control, she’s also co-creator of the misery in her life. She has chosen to define her life with negativity. Now, she may not see this as a choice. (In fact, she almost certainly does not) Stuff just happens to her. But allowing yourself to fall into the posture of a chronic victim is itself a kind of choice.

The thoughts you think, end up thinking you.

You are the co-creator of your lived experience.

If you find yourself attracted to value investing, and you come to identify strongly as a “value investor,” in addition to whatever financial returns you generate that identity probably gives you a sense of meaning and maybe even a sense of community or belonging (if you don’t see Berkshire Hathaway’s annual meeting as a form of religious pilgrimage I’m really not sure what to tell you). Your value investor identity also frames your worldview a certain way. It limits your worldview in certain ways. This can be a liability, if your value worldview is fundamentally misaligned with the prevailing market regime. In this case your identity may well turn out to be a form of maladaptation.

A static identity locks you into particular patterns of thought and behavior. These patterns are relatively straightforward for others to identify and exploit, whether in business, politics or investing.

This lock-in is what I mean by psychic prison.

Escaping The Psychic Prison

Escaping the psychic prison of identity is straightforward but not easy. All you have to do is redraw the boundaries of your identity.

This lies at the heart of zen practice, adjacent to the idea of non-attachment. After years of practice, a zen master might be able to completely erase his attachment to self–a process that might trigger a complete mental breakdown for someone unprepared for the experience. What might this feel like? Having not experienced the feeling of complete dissolution of self, I’m hardly qualified to describe it.

Fortunately, complete dissolution of the self isn’t required to break out of the psychic prison of identity. All that’s needed is the ability to consciously rewrite the boundaries of identity.

Meditation is one way to practice this. Another is acting.

Our value investor might begin working on his escape from the limiting aspects of that identity by play-acting at growth or momentum investing. This doesn’t mean completely abandoning the tenets of value investing. It merely means cultivating the ability to view the world through someone else’s eyes. It’s merely about wearing the mask of a growth investor. At least to start, anyway.

The things you own, end up owning you.

The thoughts you think, end up thinking you.

The masks you wear, end up wearing you.

Ultimately, there’s no difference between you and the masks you wear. You are the masks you choose to wear. For some this is a frightening possibility to consider. Particularly from a metaphysical perspective. However, it’s also empowering.

Remember, you get to choose the masks you wear. That’s the point of this post.

The Nature Of Freedom

True freedom is freedom from an arbitrary or externally defined definition of self. It’s engaging in the process of creative destruction.

Personal freedom is engaging in creative destruction at the level of the self. Economic freedom is engaging in the process of creative destruction in the external world. When I say engage in I mean engage in as a principal, as a force acting on the world around you. Like it or not, we’re all subject to the process of creative destruction. The difference between freedom and slavery is agency.

This is the reason I included that quote from The Rock at the start of this post. It cuts to the very heart of what it means to be free. Free people manifest their will in the world around them. Losers whine about doing their best.

The archetype of the chronically negative loser described at the beginning of this post is especially grim. Here is a person who cannot even rise to the level of whining about doing her best. All she can do is whine about being a victim.

By contrast, by this definition, Frederick Douglass was probably freer as a slave than most nominally “free” people are today. It’s not an accident that one of Douglass’s most famous sayings is the statement that “knowledge is the pathway from slavery to freedom.” There is a reason slave owners did not want their slaves to learn to read.

In this spirit I’ll close with an excerpt from Douglass’s speech, “Self-Made Men,” which I recommend you read in its entirety.

I am certain that there is nothing good, great or desirable which man can possess in this world, that does not come by some kind of labor of physical or mental, moral or spiritual. A man, at times, gets something for nothing, but it will, in his hands, amount to nothing. What is true in the world of matter, is equally true in the world of the mind. Without culture there can be no growth; without exertion, no acquisition; without friction, no polish; without labor, no knowledge; without action, no progress and without conflict, no victory. A man that lies down a fool at night, hoping that he will waken wise in the morning, will rise up in the morning as he laid down in the evening.

Faith, in the absence of work, seems to be worth little, if anything. The preacher who finds it easier to pray for knowledge than to tax his brain with study and application will find his congregation growing beautifully less and his flock looking elsewhere for their spiritual and mental food. In the old slave times colored ministers were somewhat remarkable for the fervor with which they prayed for knowledge, but it did not appear that they were remarkable for any wonderful success. In fact, they who prayed loudest seemed to get least. They thought if they opened their mouths they would be filled. The result was an abundance of sound with a great destitution of sense.

334px-Frederick_Douglass_(circa_1879)

A Pause For Reflection

200_posts

It’s a bit hard for me to believe but I’ve apparently published 200 posts on this blog since I started writing it in September 2017. When I got this notification it prompted some introspection. I went back to my very first post, Zen & The Art of Investment Research. There I articulated a hazy vision for the ideas I wanted to explore here, writing:

Some people will argue there are compliance procedures like departmental firewalls to prevent conflicts of interest from influencing analysts’ recommendations. To which I would respond with The Golden Rule: He Who Hath The Gold, Maketh The Rules.

You may quote me chapter and verse from a compliance manual. I do not care what is written in someone’s compliance manual. In practice, if ever there is a dispute between a profit center like an investment banking group and a much smaller profit center (or, god forbid, a cost center) like a research group the profit center will win out every time.

Examining applications of The Golden Rule throughout history and contemporary events is part of what this blog will be about. This blog will also be about exploring the way the world works, through the lens of The Golden Rule, without needing to worry about where we end up and whether our conclusions might cost us our jobs.

One of the things that drew me to investment research is that in its purest form, it provides clears incentives, both positive and negative, for intellectual honesty, regardless of whether something makes you uncomfortable ideologically.

I think I’ve done a pretty good job executing on that vision over the last year and a half, though my reading and writing have gradually drifted from “pure” finance and economics to more of a focus on narrative abstraction, and how narrative abstraction is used to shape financial markets (not to mention our world). I expect this to continue to be my focus for the foreseeable future.

Something I’ve spent more and more time thinking about lately, especially as Demonetized has attracted a (very small) audience, is what I want this blog to be.

One thing I’ve decided it will not be is a business. Will I potentially write other things that I’ll attempt to sell? Yes. But this blog will remain Demonetized (actually more like un-monetized). I’ve got two major reasons for this.

First, this blog doesn’t lend itself to monetization. Maybe some affiliate links. But the writing itself isn’t the kind of (shudder) “content” that works as a product.

Second, I want this blog to be a place where I can follow my interests as they evolve over time.

Something I’ve observed studying narrative is that if you’re a public intellectual, and you make a living as a public intellectual, you essentially become locked into a particular shtick over time. This isn’t necessarily grifting (though it can be). It’s a function of the fact that your followers customers sketch out mental models of you over time. These models aren’t robust. They’re brittle. They fuel what my friends at Epsilon Theory call the game of you: “mirror” or “rage” engagements.

What brings out the real emotion and the real confusion is when a mirror engagement goes awry. It’s also confusing when a rage engagement goes against type and agrees with you on something, but the reaction isn’t upsettedness … it’s boredom. The emotion when a mirror engagement goes against type is much more pronounced, much more urgent. It’s a betrayal.

Not a big betrayal. Not a personal betrayal. Not (usually) a permanent betrayal. It’s not even a Heel Turn, to use the pro wrestling phrase, when a Baby Face (a good guy) flips the script and becomes a Heel (a bad guy) in some shocking plot twist.

No, it’s more like when your favorite sitcom has a “very special episode” where they deal with some social issue du jour in a “serious” fashion that of course you find cringe-worthy. That’s not what you want from Three’s Company!

When you’ve got a dedicated audience (or maybe an anti-audience, if you tend to attract rage engagements), the audience isn’t drawn to you (a complex individual who is likely to change over time), but rather a cartoon of you (a sketch that’s appealing on the basis of prospective mirror or rage engagements). It’s this cartoon that’s brittle. Evolve your views and interests “against type” and you risk breaking the cartoon. You risk losing your audience. Not to mention your revenue.

This incentivizes stagnation.

And stagnation is the opposite of what I’m trying to achieve here.

So over time I will go where curiosity takes me, albeit with an emphasis on ideas connected to finance, economics and geopolitics.

Maybe I’ll pause to reflect again in another couple hundred posts.

ET Note: The Grand Inquisition

Below is the teaser for my latest Epsilon Theory note. The piece is a meditation on freedom, through the lens of Dostoyevsky’s parable, “The Grand Inquisitor”:

The Nudging State and Nudging Oligarchy believe they are giving us a gift: Freedom from Choice.

Except that it is neither a gift nor freedom in any sense. Rejecting it isn’t always easy and it isn’t always costless. But it’s the only choice for anyone who would be free.

Click through to Epsilon Theory to read the whole thing.

There’s an idea embedded in this note, related to the specific mechanism through which the Nudging State engages in social engineering, which is worth making more explicit. I’ve written around the edges of it before on this blog, in The Tyranny of Optimization, when I wrote:

Here you’re not staring down the barrel of a gun but rather at a smartphone screen. Here, the trick is not only convincing people to buy into your optimization, but that buying in was their idea in the first place. This is tyranny updated for the 21st century. Much cleaner than putting people up against a wall.

What I’m describing here is what my friends at Epsilon Theory call “fiat thought.” These are thoughts and behaviors you believe are your own, though in reality they’ve been engineered by the Nudging State and the Nudging Oligarchy to promote some policy or behavior.

How do you test for fiat thought?

Ask why.

“Why do I believe [whatever]?”

For fiat thought, the answer is always some permutation of “because someone told me so.” Maybe that’s a politician. Maybe it’s a business leader. Maybe it’s a public intellectual or “thought leader.” Maybe it’s a go-to media outlet (or several). Bottom line is you won’t have a principles-based reason for believing whatever is at issue.

Having your thoughts replaced with fiat thought is perhaps the purest form of slavery I can imagine. It’s like being transformed into a pod person, except you don’t even realize the transformation is taking place. In fact, to the extent you notice the transformation at all, you’ll believe it was your own idea. This is the nature of “choice architecture.” It’s a kind of rigged game–a simulation of free will.

In reading some of the responses to my note, there are a couple common threads:

  1. Aren’t constraints on our behavior necessary to some extent to have a functional society?
  2. Most of the folks who serve the State do not have malicious intentions and are sincerely doing the best they can to balance tradeoffs when making policy.

These are both excellent points. I totally agree with both of them.

Constraints on our behavior and incentive systems are terms we negotiate as part of the social contract. The negotiation process is ongoing and dynamic. It never ends. An important aspect of freedom is the ability to participate in the negotiation process as a principal. “Nudgers” do not treat us as principals. Nudgers treat us as biological systems to be engineered.

Pity The Fools

Pity the babies of 1987 and 1990, then, who left school or university around the time that Lehman Brothers collapsed in 2008. Sending around a CV in the middle of the greatest financial crisis since their grandparents were born cannot have been a whole lot of fun.

That’s Tim Harford writing in the FT. As one of those babies of 1987, I can assure you it was indeed hell to send out resumes in the middle of the greatest financial crisis since my grandparents were born.

There are a lot of good articles out there about how your lived experience in markets and the world shapes your behavior. Here’s an especially good one from Morgan Housel.

So how did the financial crisis shape me?

Mainly, it made me paranoid.

It taught me talk is cheap.

It taught me no one’s entitled to a happy ending.

It taught me that money talks and bullshit walks.

It taught me you can do business with people who wield power and influence, you can respect people who wield power and influence, but you should never trust people who wield power and influence.

Most of all it taught me that at the end of the day, the only things you should count on are your skills and your character.

Don’t get me wrong. People can be wonderful. I’ve benefited from the support of many individuals who took an interest in my career development over the years. I will always and ever be grateful for the opportunities they offered me. Particularly in the early days, when I was a poorly-credentialed career changer with the wrong resume.

But here’s the thing about people. You can’t control their behavior any more than you can control the macroeconomy.

It’s Just Business

“Your father did business with Hyman Roth, your father respected Hyman Roth, but your father never trusted Hyman Roth.” – Frank Pentangeli, The Godfather, Part II

Frank Pentangeli is one of my favorite characters from The Godfather movies. He’s a lovable, old-fashioned gangster struggling to eke out a living in a brutal and cynical world. Frank’s fatal flaw is that he’s not smart enough to see all the angles. He never fully grasps how completely he’s at the mercy of forces much larger and more powerful than himself. He clings to a code of honor that seems increasingly outmoded as the plot evolves.

And so, it’s fitting that when Pentangeli finally goes out near the end of Part II, it’s not because someone whacks him. It’s because Tom Hagan convinces him the only way to salvage his honor and dignity is to off himself. The scene is one of the best in all three movies.

In Epsilon Theory speak, Frankie Five Angels is a lousy player of the metagame. (h/t to Epsilon Theory for inspiring this post, btw)

godfatherii_tom_frank

Despite Frank’s obvious flaws, his acute sense of personal honor was useful when it came to judging the character of his business partners and counterparties. His most famous line (quoted above) is a testament to the fact you can always choose to do business with someone at arm’s length. Trust is not a prerequisite for a mutually beneficial business relationship.

So it is with the sell-side.

We do business with the sell-side. We respect the sell-side. But we should never, ever, under any circumstance trust the sell-side.

I was moved to reflect on this after another one of those “market outlook” meetings where a “portfolio specialist” (a salesman with his CFA designation) from a big asset manager comes and talks to you about how the next recession is at least a couple years away* and sure there some risks but nonetheless the fundamentals are sound. Oh and by the way have you looked at leveraged loan funds lately?

Sure, leveraged loan covenants suck, and the space is red hot, and investors will get burned eventually. But there’s still a couple years left in the trade.

Sure, high yield looks like a crap deal on a relative basis, but on an absolute basis there’s still a supportive bid for yield from foreign buyers.

Sure, this stock trades rich, but our analysts can see a path higher from here.

How many times have you heard this stuff? Or stuff that rhymes with this?

Our relationship with the sell-side should always and everywhere be a transactional relationship. But the goal of every great salesman is to turn a transactional relationship into a personal relationship. Personal relationships bring with them all kinds of social conventions and obligations. Unless you’re a complete sociopath, it’s nigh on impossible to behave in a transactional manner once a business relationship turns personal.

That doesn’t mean you can’t go to lunch with the sell-side.

It doesn’t mean you can’t use research from the sell-side.

It means you should never, ever under any circumstance allow yourself to believe the helpful guy or gal from the sell-side you have lunch with once a quarter is truly on your side of the table, always and everywhere with your best interests in mind.

If you do this, and you choose to trust these people instead of merely transacting business with them, you will eventually discover that they do not, in fact, sit on the same side of the table as you. They do not, in fact, suffer like you when the bill of goods they’ve sold you blows up.

And it’ll cost you.

*The next recession is always at least a couple years away.

How Much Is Enough?

Money is a funny thing. As a unit of exchange it is the raw material for consumption (or, if you prefer, the deferral of consumption). We express who we are through our spending. It’s no surprise then that the answer to “how much is enough?” varies wildly from person to person. But really what it boils down to is an optimization problem.

Contrary to what people think, the hard thing about answering “how much is enough?” is not calculating a dollar amount. The hard thing is deciding what constraints to apply to optimization. Once you do that, the calculations pretty much fall into place on their own.

At a high level, we are looking at the following function (let’s call it the Enough Function):

Enough = Present Value of (Future Lifestyle Spending + Future Basic Needs Spending + Desired Margin of Safety)

Obviously you can disaggregate each component (Basic Needs Spending would break down into line items like “Housing” and “Essential Food”). For the purposes of this post I’ve opted for brevity.

In principle optimizing the Enough Function is pretty straightforward. In practice people find it difficult for a couple of reasons. For one, most people live like sheep. They follow the examples set by advertisers, movies, TV shows and the people around them.

We can partly blame evolution for this. A million years ago if you didn’t fit in with the rest of your tribe you would be ostracized and could look forward to dying cold, hungry and alone. We are a long way from those days and yet our evolutionary programming dies hard. Most people have not spent much time thinking what actually gives their lives meaning. So they look for meaning elsewhere.

On a more mundane level, quantifying a margin of safety can also be tricky. There is just no way to gain absolute certainty. Margin of safety is best addressed with scenario analysis, which is beyond the scope of this post. In fact, for people who are totally lost when it comes to this stuff, a good reason to hire a professional financial planner is to delegate the analytical work to someone with expertise.

I don’t have a position on whether it’s “better” to live frugally or not. If we’re looking at the continuum of spending patterns, with Mustachianism on the frugal end and Kardashian-esque conspicuous consumption on the other, I suspect most people plot somewhere in the muddy middle.

Personally, I tilt a little more toward the frugal end of the spectrum. The main reason for this is that most of the things I enjoy doing (reading, writing) are not particularly expensive pursuits. But do I think people who want to drive nice cars and live in big houses and spend lots of money on clothes and jewelry are “doing it wrong?” No. Their Enough Functions are just optimized for a different set of constraints.

The Root Of All Most Financial Problems

Financial problems result from mismatches in the optimization of the Enough Function and the financial resources at hand.

It is okay to make a ton of money and live the high life. It is not okay to make very little money and live the high life. Unless you are optimizing for a crushing debt load and eventual bankruptcy, of course. Fortunately, if you find yourself in this position there are a couple levers you can pull: spend less or make more money.

Like I wrote above, this stuff is really simple in principle. The challenge comes in the implementation, but it’s mostly a challenge of self-discipline (on the spending side) and hard work (on the income side).

When Obnoxious Salespeople Attack

A couple days ago I listened to one of the worst investment pitches I have ever heard. Its manifest awfulness had nothing to do with the investment strategy on offer and everything to do with the presenter.

My colleagues and I endured approximately half an hour of some guy literally shouting at us about how great this fund was and how the fund’s investments have averaged 24% IRRs. The presenter paced like a caged animal for the duration of his monologue, punctuating the pitch with exclamations of “got it, people?!” and “okay, people?!”

I imagine this is kind of what it was like listening to Mussolini speak publicly (if Mussolini had been a real estate guy, anyway). Browbeating prospects into submission was the cornerstone of this guy’s sales process. Not a good look.

Of the myriad varieties of aggressive salespeople, aggressive financial salespeople are probably the most hazardous to your wealth. They are almost always selling you something pro-cyclical and frequently there is financial leverage on top of the cyclicality. (Where do you think the 24% IRRs come from?) This is stuff with significant go-to-zero risk. Caveat emptor.

Nonetheless, I’m fascinated by the psychology of aggressive salespeople. They are okay at making money but in my personal experience at least pretty lousy at hanging on to it. I think that has to do with pro-cyclicality, willingness to take on lots of leverage and a general predisposition toward gambling. These guys live like Thanksgiving turkeys.

turkey_happiness_graph
Source: Attain Capital via ValueWalk

Early in my career I had a number of colleagues who spent time in subprime lending. One of them described how at the peak of the cycle the reps would all be driving sports cars. Then when the cycle rolled over tow trucks would show up to repo the cars as the reps defaulted on their auto loans, same as their customers. You would think people in the subprime lending business would have a better grasp of the credit cycle. But you would be wrong.

To me this is further anecdotal evidence that pro-cyclicality and herd behavior are hard-wired into human nature. But it doesn’t make listening to obnoxious salespeople any easier.