The Virtues of the Market Process

It is not because it brings about better outcomes for the best. It is because it is the most reliable method for bringing about better outcomes for the least. 

The market knows (and continually discovers and improves upon) what otherwise cannot be known: where, when, and how much to do what. 

This is in part because the market aggregates knowledge in a way that creates better knowledge and in part because the market communicates that knowledge effectively. Both parts work in tandem as the process is a continual positive feedback loop. 

Key to all of this is the market process's combination of two powerful forces: incentivizing the pursuit of knowledge and rewarding the discovery of knowledge. 

As a market participant I am invigorated and rewarded for bringing about better outcomes for others. The eventual effect of this across all participants is to satisfy the infinitely complex and conflicting desires of ALL others, and this happens in each instance of market activity because prices, the market's tool for communication, encapsulate all desires in a single, universal signal. 

The hallmark of the market's achievements is how from nothing comes more and more (resources) to give us more and more (happiness) for more and more (people). 

Two Short, Partial Lists . . . More or Less

We don't just have wants; we have wants about our wants. 

                    -- The philosophy of Harry G. Frankfurt as channeled by Russ Roberts

Things I would like to like less: 

• Football
• Running errands
• Donuts
• Saving and salvaging old stuff
• DIY
• Collecting
• Piddling around the garden

Things I would like to like more: 

• Baseball
• Exercise
• Tea
• Live concerts
• Playing golf
• Attending church
• Math

This is a very partial partial list. I could go on and on. And it changes over time, but these items are fairly constant. 

One might say that I am yearning to be someone else, and that would be partly true. Such a yearning can be a healthy aspiration or a smothering burden. I don't think I'm deluding myself to believe I keep it on the healthy side. 

And this is more about how I wish I ticked rather than how I wish I acted. Any good economist rightfully responds to the statement "I want to have X" (where X is a new job, a Ferrari, more time to travel, etc.) with the terse reply "Obviously, no you don't."

While these are not desires I can completely bring about, I can work on them. Perhaps I should/will, but perhaps I'm partial to leaving aspirations as they are.

Timelessness of Seinfeld Rendered Untimely by Tech Changes

Seinfeld, the greatest  sitcom in history (a title I don't give lightly), has a humor that I believe is timeless. However, most of the episodes contain elements that are today impossible because of technological advances. Obviously this is applicable to a great many movies and TV series episodes of the past. 

Here are some examples from Seinfeld where the main premise is null in today's world--mostly because of mobile phones and the Internet:

• S1, Ep2 The Stakeout - Jerry and George stake out the lobby of an office building to find a woman Jerry met at a party but whose name and phone number he didn't get.
• S2, Ep4 The Phone Message - George leaves several awkward messages on a girlfriend's answering machine, then decides to steal the tape.
• S3, Ep6 The Parking Garage - The four get stuck in a parking garage for hours when they forget where they parked.
• S4, Ep14 The Movie - Jerry does a set at a comedy club, then goes to meet George, Elaine, and Kramer afterward to see a screening of Checkmate. However, a simple miscommunication causes the four to keep missing each other at two different theaters.
• S7, Ep8 The Pool Guy - Kramer discovers that his phone number is one digit off from that of a popular movie-finding service and offers help to those that mistakenly call his number.
• S9, Ep20 The Puerto Rican Day - Jerry, George, Kramer and Elaine get stuck in standstill traffic due to the massive Puerto Rican Day Parade.

P.S. After creating this list I had the good sense to Google it. No surprise there has already been extensive research into this phenomenon. 

Failure Due to a Lack of Imagination

How can you possibly have this without that? 

How can we have great TV without commercials that are viewed? 

Journalism without newspapers? 

Lending without banks? 

Currency without gold backing government issuance? 

Meat without slaughtered animals? 

Cars without gas? 

Cars without drivers? 

Mail delivery without a U.S. Postal Service?

Etc... 

If the demand for X is there, supply will come. The specific means of supply are almost always sufficient but not necessary. In fact the means of supply are constantly shifting and fleeting as competition makes sand of once sturdy foundations. 

This is all for the better for society no matter the temporary pain specific producers must endure. We hold back change, question new developments, innovations, and techniques, and stifle entrepreneurial exploration all for lack of imagination and faith in the process. 

It is not just regulation where government is aiding the bootlegging vested interests at the behest of the Baptist worriers. We see slow adoption and disapproving dismissal throughout society--all the way from concept to highly proven result.

Yes, there is another side to this. Chesterton's Fence is an important force for good. But it is just a starting point in the conversation about change asking us to slow down and consider what we may not fully understand. It is not an ironclad rule that change must be bad. And it fades from being relevant as those with the most at stake and who are the most involved are the ones leading the way for change.

Related: https://stratechery.com/2020/never-ending-niches/

Two Methods of Improvement

Let's compare two general methods of improvement: 

1. Truncating the left tail so as to eliminate the undesired portion of the distribution
2. Increasing the distribution so as to grow (fatten) the right tail and therefore increase the desired portion of the distribution. 

Both methods have the effect of shifting the mean rightward. But the first is artificial.

Let's explore the first method. People paid primarily for their looks are an example of truncating the left tail. (One might be tempted to say “supermodels”, but that is a particular, specialized subclass of this universe. It is like saying basketball players when we are actually talking about athletes.) They exist within a distribution of attractiveness (subjectively considered as that is the only way) that simply has lopped off most or all of the left side. Some are gorgeous to you; others are gorgeous to me. Some are not so attractive to you while others, perhaps ones you really like, are not so attractive to me. Anyone in particular within this group might be just okay to any random observer. Taking everyone's opinions together as a whole, though, on average gives us an ordered distribution [similar to the theoretical and problematic Keynesian Beauty Contest]. 

When considered from the average observer’s viewpoint, the only thing missing in the distribution are all those who would be below some threshold. In other words the “lowest” (most left) person paid for looks is just an average looking person compared to all of humanity. Because we can’t manufacture attractive people yet, we are forced to use the truncate strategy. 

So the only way to bring about beauty improvement is by leaving out those who are less than some level of beauty (I used eliminated everyone below the average beauty score in the example). So we can get there, but it is artificial--we just left out the less than "beautiful", whatever that actually means in this hypothetical.

Now think about wealth. How do you increase average societal wealth? This is problem from a different realm because unlike beauty where we are currently limited to some degree of diet control, physical fitness training, and plastic surgery we can move wealth around. 

In the case of wealth what is the better path: Minimizing the impact of bad ideas (truncating the left tail via redistribution) or increasing the rewards for good ideas (fattening the right tail)? 

Bailing out bad ideas has moral hazard risks--we are subsidizing bad ideas. When you subsidize something, you get more of it. Taken to the extreme income redistribution is not sustainable. The system collapses in on itself through actual complete resignation (a dead-end Nash equilibrium) or deliberate exit (John Galt). Because of this, we are forced to use the grow the distribution strategy. 

Notice how this distribution is truncated and non normal (there is a minimum at 70 and the distribution has a right skew). No one is below some level of actual wealth (even debtors and prisoners get a meal and a place to sleep). So in some sense I am assuming some of the first strategy--a social safety net of some kind. I wanted to make it more realistically skewed, but time didn't permit. However, we should be careful how easily we succumb to the notion that there are people with true wealth at the far, far reaches of the distribution. Just how rich is Jeff Bezos compared to you or me really, seriously? 

Growing the distribution has a side benefit of minimizing the impact of bad ideas--a kind of resistance to bad ideas having meaningful, lasting impact. Subsequently the opportunities for good ideas are increased since this method is positive sum (it grows the pie) while the former strategy is zero sum and eventually negative sum if taken too far.

Am I assuming too much? I really don't think so. 

Unfortunately, advocacy for method two is unpopular because of social desirability bias. People don't want to admit that they want the rich to get richer. Or worse yet, they think letting the rich get richer somehow makes us all worse off. 

Dynamic versus Static Investments

One way to categorize investments would be dynamic assets like stocks and bonds and static assets like commodities and art. 

Investment taxonomy is multidimensional. Along one dimension would be concentration/dispersion diversification. For example owning stock in one company alone as compared to several companies within the same industry as compared to several companies among different industries. Still a greater level of diversification can be achieved as an investment portfolio approaches a share in all companies (e.g., broad-market index funds).

Along another dimension would be type of return claim. A stock investor has a residual claim to the profits that remain after all other claims have been satisfied. That is after all creditors have been paid--all liabilities have been settled. A bond investor (lender/creditor) has a primary claim putting them somewhere higher up the priority list. Keep in mind there are various levels for various types of debt issued. 

Along another dimension would be whether the investment generates cash flows or is dependent upon perpetual new buyers at higher prices for its rate of return. Consider my prior partial list and the explanation behind the distinction. 

Still another dimension would be how dynamic are the assets one is investing in. Can the asset maintain or gain value in a changing world? This is where I would like to focus today.

In my thinking dynamic assets are essentially investments in ideas with potential cash flows. Static assets are essentially investments in inputs (costs) where the market is continually working against you and high-risk speculations on future tastes and technologies (future desirability & greater fool theory rolled into one speculative bet). 

With static assets you can be right and still be wrong. The opposite is true of dynamic assets to some degree as businesses can change direction. 

Since static assets have a locked-in nature, they should command a risk premium. Indeed they do but it isn't necessarily sufficient compensation for the added risk of loss they offer. 

The general case is that the more dynamic an asset is the lower its experienced volatility and thus the lower its expected return. But there is more to this story. Volatility is a cruel mistress. It can rob an investor by impairing capital because of the pattern of returns--negative or even just low returns at the beginning of an investment horizon while cash is being pulled out can leave the principle so low that eventual recovery is not possible. Therefore, a static asset with high volatility and high expected return might experience high (negative) volatility, prices going down rapidly, at just the wrong time, early in the investment horizon. Dynamic assets can be the slow and steady that wins the race. 

Volatility's cruelty doesn't end there. It can collapse and vanish as well, but this leaves investors with low expected returns. A static investor needs volatility to justify future returns. 

One should not assume I am saying that one is preferred necessarily to the other. Rather this is one exploration into how assets can be categorized and how to think about investments. Assets along this spectrum fulfill differing objectives with differing opportunity/risk characters. Investing is about tradeoffs.

Consider this stylized linear example: 

Forever people have been trying to eliminate oil: first they were doing so because it was nothing but a nuisance, next they we're doing so because it was getting more and more expensive as more and more of the world's machines ran on it where the solution was to find more and more of it and produce it cheaper and cheaper, and now substitutes are becoming a better and better option. 

To bet on a technology one needs to be compensated for risk with commensurate returns, and because the chance of a given technology profitably working is incredibly small, those need to be exceptionally high potential returns. In that case don’t own oil; own mineral rights. Don’t own proven reserves; own unproven reserves. Don’t own production; own potential production. 

Oil was to the 1920s what cryptocurrency assets might be to the 2020s. Bitcoin, Ethereum, and all other crypto assets are bets on a particular strategy within a particular technology.  So invest with care. These are highly speculative and certainly very static within my classification. Do not mistake the dynamic ability of people and firms with ideas and fluidity to be attributes of the underlying crypto technologies these people and firms may be employing. 

One last example: Diversified real estate is a dynamic asset while concentrated real estate is static. Similarly investment in the rights to a franchise within a geographical area is more dynamic than is the franchise location itself and even more so than the specific land the franchise sits upon. To this end see the picture below and keep looking until you see it:

The Surprising Truth About the 2016 Election

Which major political party of the late 1950s won the US presidency in 2016? It turns out the 1960 Democratic Party won both the 1960 election as well as the 2016 one. 

To illustrate why this is true, I recently perused the 1960 Democratic Party platform and the 2016 Republican Party platform selecting key slices for comparison--links below, but read the rest first. While this is certainly subject to lack-of-context and selection biases, I think it is a good glimpse into a larger truth about the evolution of our politics. 

Make no mistake about it, I think this is an overall positive development and not the case of a need to "restore the true Republican Party" etc. As others have pointed out, where Republicans are on many social issues today represents great progress, but the same can be said for Democrats. 

Keep in mind as well that a lot of this is a case of the 'more things change, the more they stay the same', 'nothing new under the sun', and good ole 'will it play in Peoria?'--the resonating American themes are largely constant over time. Perhaps most importantly these documents have always been empty rhetoric. It would be a grand and interesting undertaking to go platform by platform through the years to show all the empty promises and outright contradictions when compared to actual pursuits and results.

With all of this considered, read through the two groups of selections below (after the jump) from the 1960 DNC and 2016 RNC platforms and see if you can identify which is which. Both are excerpted in order as written except the very last paragraph in one as identified. That might give some clue as to the prioritization, but then again it might mislead. Incidentally, in terms of prose having myself read both in their entirety, the 1960 Democrats were both much more succinct as well as streets ahead in elegance.