Value in our 21st Century

Tom wonders about money


If you like to follow my kinds of lines of independent thinking, maybe you'll like these thoughts.

This essay is not about capitalism vs socialism, so let me just get that out of the way. I'm on both sides, and I think everyone else should be too. On the one hand exchange improves the world, generally. Every transaction without externalities or inequality in power and information improves the human world, since each recipient wants what they got out more than what they put in. Who can argue with that? Exchange increases net value. Yet when someone can make money by screwing others, they may consider it their job to do so, since that's how they get paid. And who can argue with that either? This will remain as true in a thousand years as it was a thousand years ago when William the Conqueror took over England. So it's good we have a society that encourages and supports exchange, and also downregulates the sociopaths, perhaps not enough but at least to some degree. Fair enough? Okay enough about ideology.
What I'm wondering here is about money and value, because it's a time when our past assumptions seem to have become questionable. Let's begin.

Price discovery occurs when supply meets demand, when buyers and sellers agree, at that mobile meeting moment when the balance of forces on each side of the transaction equal the other and its tiny lightning strikes. There might be a published bid/ask gap, and based on a greater need on one side, a buyer or seller will bridge the gap, which then moves the current or actually most recent agreed price away from the needier side's proposed price. It's in these transactions themselves that price discovery actually occurs. That's a low level, mechanistic view of price discovery, in the bid/ask gap bridged by an actual transaction.

A higher level view describes what is behind those forces of need. Consider two price discovery models: smart money and forced flows.

First, smart money: Let's assume there are counter-betting populations of smart investors with plenty of backup investment options. They can pull their money out if they want; they have some idea of the value of things; they can and do notice if a price is below its value and if so they buy according to their confidence and size of their wallets until the price is bid up to the value, within epsilon. Epsilon is the error of this model, equal to the transaction cost plus perhaps some amount related to the other investment options available (if your other options are marginally better, you won't throw money at this asset which hasn't enough margin of value-price in comparison with your alternatives).

A second model is forced flows, a balance-of-flows model, where the bidding up or down in price of some asset is related to the flow in and flow out of the asset. It's not necessarily based on some independently-derived sense of value of the asset, but simply, without knowledge of value, the flows into the asset. I have in mind that if a society of workers is all working all their careers to put some retirement money away, plus companies matching, and most of them are forced to put this money somewhere, and so they essentially throw their money wherever their financial advisers recommend, that is to say into a diversified portfolio of stocks, bonds, and ETFs, then irrespective of the true value of such portfolio's underlying assets, these flows will automatically flow and bid them up by the amount of their retirement contributions every month.

This flow model can work in the context of ignorant investors guided by self-interested advisers who make money on the churn in the investors' portfolios. Since there is not much churn in real estate, they don't advise going there sufficiently. And given the indexing argument that you should invest in everything in proportion to all the relative asset values, investment can be carried out in complete ignorance of true underlying valuations, and even Warren Buffet tells people to follow that advice (cf his public million dollar bet against active managers versus the S&P index, which was lost by the opposite bettor). The indexing bet takes no knowledge, yet is far better than a bet on the average actively managed fund. Thus we discover not only that the stupidest bet is a great bet (based on the indexing argument) and further that the entire world of mutual funds and following the advice of the financial advice industry is even stupider than that stupidest bet, and yet huge cashflows are continually going into the stock market based on those paths, the paths of minimum and negative total intelligence. Huge, huge cashflows, because everyone is putting money algorithmically away for retirement.

I'm not just being arrogant and supercilious and saying everyone is stupid, that's not it. It's not an easy problem. To win a bet against the market means you not only have a sense of the value of the asset, but also of other people's estimates of its value, and also of the time course of a change of their estimates of its value. If you know all that then, Yes, you can put some level of confidence onto a buy and sell model to make some money on, with dates or prices that can be predicted in advance, to some degree. Having all that information is a high bar, but not impossible.

Here's a tiny example of my own, only for illustration. I felt I knew all those elements recently, to a small degree of confidence, and I made a Covid-19 bet on Gilead (GILD).

It was thrashing up and down wth the whole market at the time Covid was coming into wider awareness, after many months in the range of about 60-64, now it was in a range from 64-84, mostly based on fluctuating news of studies of its drug, remdesivir. I heard through my own grapevine that the first US Covid-19 patient had used remdesivir and his fever has dropped from dire to no big deal in 24 hours after administering it. To me that's not perfect information but it's a valid and direct signal from the underlying reality which is quite suggestive. It's probabilistic knowledge, even from a single data point. Obviously others would be finding this out too, and during a time of fear froth and volatility people are going to bid it up, but not too much because even if it cures Covid-19 it won't necessarily make Gilead double their already enormous (44B) company valuation. And I had a floor, because it is a big pharma company with plenty of value outside its remdesivir position, not much below its then-current trading price, so it probably wouldn't tank completely at least not soon. So I thought in advance, next time they go down below 70 I'm buying, and I'm sure it'll pop over 80 some time, it'll be a fine bet and I'll sell then. Not that I had infinite confidence in this, but I had enough to bet $7000 to buy 100 shares. So I did, and it did, and when I sold them for $8000 a couple days later I made $1000, a tidy profit but a small fraction of the market-wide losses I more than shared in in my own index fund investments.

Now two months later it's still trading around 76, having spent maybe a day in the interim trading above 80. So I feel that that was a good bet. I had a sense of the impact on its potential value as being far from a doubling. I had a sense of the timing of investor sentiment, based on the visible wave of exponential growth and universality of the Covid pandemic infection and death curves coming at us, which were not widely acknowledged but obviously were going to wash over the US and therefore over the mass of market participants. I could feel the timing of tidal wave of investor sentiment coming, which I expected could waffle with good and bad news but that yes they would rush in with some good news some time, and their interest would be scaled by the derivative of the investor need for that news (greater panic would mean higher price). Given my own experience of Covid panic when I had realized O God this is Real, I could see the spreading sense of panic around me at about the time of the initial shutdown, when the country started finally thinking this is real, it was hitting home, that investor sentiment trajectory was quite visible in the news and the numbers, and the moment of maximum distribution of the O My God sentiment was my time to sell. Perfect. Except despite my thesis I didn't have the confidence to bet heavily on it.

So my point with that story is not how smart I was, but how rare an occasion arises where smarts actually is meaningful. I've had two bets like that in my life where probability said Go for it!, and in a now somewhat older life, that's not a lot of occasion to be smart. So if our model of investment price discovery is some mixture of the smart money and the forced flows, the stupid money simply flowing, and smart money betting on mispricing events, to me it seems that the amount of smart money out there is maybe less than the amount of stupid money. Maybe a lot less.

And if so, it would make sense that when the government prints a few trillion dollars, the prices in the whole stock market would go up. There's a lot of spare money floating around, it has to go somewhere, it might as well go to float the whole stock market up because that's as good as Warren Buffet's advice, so we all advise our advisers to follow their advice and direct the flow there, and up it goes. Maybe there's no inflation in consumer goods, but there's huge inflation in investment asset pricing.


Another point is relevant at this moment in history, as tech takes over. Every business is becoming a software business. AI and Robotics are taking over all kinds of jobs. I myself got a patent when I worked at Spoken on how the computer can help the call center agent, or over time the call center automatic dialog system, to recognize caller sentiment in order to actually make sales. That job was all about call center automation, and even what wasn't automated away by the speech recognizer with the grammars I wrote was still sent overseas to low-cost labor countries or home where folks could be in the call center with a computer and a telephone at home, driving the value of labor toward zero.

Andrew Yang reports that the head of the Service Employees International Union says that the future of work is no work. When call center jobs go away to Spoken, and retail jobs go away to Amazon, and future transportation and logistics jobs go away to robot cars and trucks, and future construction jobs will go away to scaled up 3D printing, even a simple plumber has plenty of ideas for robotic plumbers. This sh*t is coming, and it WILL hit the fan.

From a money perspective the basic trend from technology in general is deflationary. A farmer with a hoe feeds a family, but a farmer with a tractor feeds a village. The labor cost of food goes down as technology develops. Not just food, but everything with a labor cost in it, consumer goods, business goods, employment itself all goes toward zero. And this is a good thing from one perspective because it moves towards a post-scarcity consumption society, in which the labor cost of plenty for everyone becomes less and less. But the other side of the transaction, the supply side, looks much scarier.

The central fact is that one software program written and debugged one time can do the work of unlimited workers over unlimited time. John Henry will certainly die in a race against these steam shovels. Will John Henry have a replacement job when the improvements in technology change their character from aiding humans in doing more and better work to replacing humans entirely? The old Luddite argument, that technology is taking our jobs, was certainly temporarily wrong during the massive expansion of the manufacturing economy since 1816, when if one kind of work went down another came up. But the old Luddites will certainly be ultimately proved correct since obviously the robots are coming. It says, Hey, most of you, your labor isn't worth anything now. What are you going to do about it, eh, when your income is your labor exchanged for money?

Okay so technology is deflationary. In comes tech, down goes the labor cost of production, down eventually (if there is competition!) go the prices, down down. And yes it's good because life should be easier for everyone when things are more affordable, but no it's also bad because noone can afford anything when they aren't working for good money.

Perhaps our moment in history can be analysed into an inflating part of the world and a deflating part of the world. Technology drives down the cost of apps and information, amazon free delivery, all deflationary and good for fixed income consumers. And money-printing state banks and governments drive up the price of investable assets, as the subsidized rich who actually receive most of that government support just put their money into even more luxury condos and stock investments. Investments' prices go up even as lots of things are going down, both costs and, for most, incomes.

What is real money is such a confusing future? I always thought, yeah, money is sort of like money but it doesn't always behave like money: inflation eats it up and then it's not worth that much any more. I always thought, No, the better measure of value is rental headcount. How many people do you want to have paying you rent, how many would that do to give you an income you could live on. That's the real question. Probably your number is more than one, maybe one might pay your own rent, another your taxes, and a third your actual living expenses. Something like that, because over time if inflation raises the meaninglessness of money, you can raise your rents and it's all good.

Here in America we might not be planning to let the working class go off in the forest and die; therefore, they will certainly be paying rent somewhere, so some multiple of headcount times C class residential rents in todays money, tomorrows money, any imaginable time's money, should pretty much keep you in mac-and-cheese if you can get that many houses paid off in your portfolio. Yes, I'm saying I actually don't believe in money and I don't care what happens to money, because I have my couple of houses, and you can go ahead and pump your trillions of printed money into the economy and I should still be good.

Except if ...

Except if America says, F*** the formerly working classes, they have no value in our new software economy, let them go into the forest and forage or starve, and with our new robo-cops we don't even need a few suck-ups to man the gates against the starveling masses any more, we'll live happy on our robot-mowed estates, it's fine let's let the population go down.

In that repulsive, revolution-worthy future, my houses may be worthless indeed. Especially as the population crashes from 2050 forward, the real estate asset bubble sags, the remaining tenants all move upscale and the crappy houses get bulldozed.

I'd rather bet on the working class though, myself.

Okay, what to do, how to think about money and value, when money is a-printing (for the rich), but services and goods are a-cheapening (for the poor). Andrew Yang is certainly right, the Freedom Dividend, Universal Basic Income, or UBI, will be necessary sooner or later, if people are to remain consumers despite having no jobs. For if the consumption economy society sags, then the riches of the rich, which exist in consumer-product company stock and C class rents will also sag. Even UBI's generosity of spirit only solves a national problem when it's actually a global problem. What about the poor countries when the robot builders target even the low-value jobs of their textile workers and miners? Let them starve? Even if the US and Switzerland can print money for a universal basic income and remain financially stable, can Pakistan also print money for a UBI, while remaining stable? It's very unclear, and maybe, probably, not. Which predicts a lot of emaciated bodies in the forest. And soon.

What to do, what to do? Public policy, private policy.

If the cost of consumer goods goes to zero, then an income of zero would pay to live comfortably. It's like that math question, what is X/Y when X and Y approach zero? We are facing a problem in the limit.

I notice that a generous UBI costs a lot less in a world where consumer prices are substantially deflated. Let's agree then, that a UBI is necessary wherever affordable.

Can we at least differentiate between the labor cost of goods and the natural resource cost of goods? Marx said Capital is just saved up Labor, which is true enough (except for the large fraction of all Money that is just invented bank-account balances (yes: see step 4, footnote, paragraph 3, here), and in this asset-inflation game the asset-holders and the printed-money beneficiaries win, while the moving costs in the economy drift downward where based on software-replaced labor, but float perhaps more slowly down where based on limited natural resources independent of labor). Like, certain kinds of mine-owners might do well over time. Gold, bitcoin, ugh. This is ugh-ly.

And natural monopolies may do well, if monetizeable. Open source software, Nope. Netflix, Yep.

Actually this forces me again back toward real estate, but I have to say now, Quality real estate. Location location location is what it's all about, and location is an intrinsically limited asset.

Okay that's an economic model of price discovery, an investment philosophy, a future trend assessment and a public policy prescription. Fair enough? Fair enough.

You know, these are some experienced-as-original thoughts by someone who actually doesn't know very much (though recently influenced by Nassim Taleb and Jeff Booth). So of course you have to figure it out for yourself. Because the question for a reader is not, Was it fun to read, or Did I think I was smarter or Did I think I was thinking, as I went along with those thoughts. The question I'm aiming to help with is, When I think about it myself later as I assess things with my own skin in the game (thanks Nassim) what do I think then, and does this help me then? I hope I help you then.

Tom

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Copyright © 2020, Thomas C. Veatch. All rights reserved.
Modified: May 17, 2020.