Value in our 21st Century

Tom explores fundamentals around money.


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, because 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 gave away. Who can argue with that? Exchange increases net value. Yet on the other hand when someone can make money by screwing others, they will 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 now is a historical moment in which 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.

Incidentally, this amounts to an assertion that there is no such thing as (instantaneous) market equilibrium, which is the basic assumption of the discipline of economics. Market equilibrium perhaps can be calculated afterwards by integrating over long enough a period of time that at least one transaction has occurred within the period, but that could be a very long time. The visible actual equilibrium in a market be mere inactivity, with no price discovery at all. Whereas for "active equilibrium" to be meaningful it would imply not just that the seller and buyer are ready to sell and buy at the same price now, but since the duration of any transaction is zero in principle, and once there is an agreement, the deal is now done and it's time to consider the next transaction, this also means that the next transaction must also be ready to go right now also, by the meaning of equilibrium, which is a state that lasts for a non-zero duration of time, and therefore must contain any number of zero-duration transaction events. Thus also the next, and the next, without limit. It follows mathematically that equilibrium's existence implies infinite market velocity and infinite instantaneous transaction volume. Therefore market equilibrium cannot exist, in this view. What is actually in equilibrium is two sides staring at each other across the No Man's Land of the bid/ask gap. And that can certainly last for as long as you want.
Viewing money as the measurement space, the metric, the field on which such pricing events occur, the value in money is:
  • initially, and perhaps when questioned by market-driving skeptics: in exchange for known external value, like gold, but then also,
  • the intrinsic utility, the quality of being-able-to-use-it, like when I bought some Ether it was so I could write code to use it to do cool stuff, it's valuable to simply be able to do those cool things with it (and this alone was enough to start the Bitcoin fire). Then,
  • because of social convention -- however that may be agreed by many, though that is ultimately crowd-fickle. Then also
  • in its non-debaseability, for even Venezuelan, Zimbabwean, and Weimaran money was still useful if you could both get it and use it in two exchanges very quickly before its value went down again. These show crypto as vulnerable to whale selloffs, but also to whale buy-in, thus bigger is better, being less vulnerable because the whales must be really big in a big pond, thus bitcoin über alles, but still subject to the risk of Satoshi selling. A less Pareto (relatively concentrated) distribution of holders holding makes a crypto coin more stable -- i.e. *seemingly* non-debaseable. And although American money has been hard to debase, its printers seem to be trying their best, so it is or was good, if you could get yours while the getting is good, but soon the idea will be to convert to real money, real value, if you want to keep it.

    So what is real money, real value? It is the holding of anti-fragile assets. Anti-fragile assets benefit from time, stress, and the rare, but not truly unpredictable, extreme ups and downs, rather than being destroyed over time and through stress and chaos. If the sum of weighted holdings outperforms in its wins and doesn't underperform, or at least survives, in its losses, it is anti-fragile. Life is anti-fragile, because it is strengthened under (moderate) stresses. A company with smart, honest management, uninterruptible cashflows, and plenty of discretionary capital available is anti-fragile since it can adjust its options quickly under changing circumstances and will capture unpredictable wins as well as survive unpredicted disasters. Fragility: inflexible management, or lack of a cushion for both survival and opportunities in future rare events or destructive circumstances, which can drop your asset to zero, and it's hard to bounce up from zero. Anti-fragility is a mixed portfolio which doesn't have to predict the future to succeed, because your hedging bets on big wins can be cheap, and your safe bets to maintain value across economic chasms and disasters should be plentiful. Then ignorance, honestly recognized and allowed for, can beat any genius whose timed bets will on average reliably lose (cf Newton's bets).

    Now, above, we saw 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 hydraulic, being a matter of simple forced flows. It is 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 they lock in the hose connector to pipe their contributions into a diversified portfolio of stocks, bonds, and ETFs, such that, irrespective of the true value of such portfolio's underlying assets, these flows will automatically flow and continue to bid them up by the amount of their retirement contributions every month. Forced flows.

    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, such advisers 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 confidently 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 it, 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 with 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 personal contacts 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 S&P 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 good, and indeed it has the hard-to-acquire joint prerequisites of a good bet. There was a good floor. There was a sense of the impact on its potential value as being far from a doubling. There was 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 Oh 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. What a turkey!

    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.

    Maybe there's a lot of turkeys out there, pecking their feed and waiting for slaughtering day. Listening to Nassim Taleb, one draws the lesson that having a great forecast or model is actually not even the point; instead, acknowledge your ignorance and create a portfolio of options that makes you a winner irrespective of whether the outcome is good or bad. If you can buy some cheap options to cover the extreme conditions, then you're all set irrespective of unpredictability. Whereas if you don't do that, then when rare, unpredicted, unpredictable events carry most of the value, if you didn't get them right you lost everything. An anti-fragile approach gets stronger under volatility. Thus, mortgage bankers play an anti-fragile game. If employment drops, etc., someone has unpredictable hiccups, they lose their mortgage, no problem, from the banker's perspective. Volatility is the banker's friend. The bank gets the lowest-risk part of the homeowner's income, who has to give every last dollar if their income drops to barely sustaining the mortgage, to the bank. Anti-fragile. So much for mortgages, which are a good idea in good times.

    Next, banking in general. This is from Richard Werner. When the bank loans you money, that's a money-creating event. In classic double-entry accounting form, on the one side there is the bank's purchase/acquisition of a security in the form of your signed commitment to pay it back. That's what they get. On the other side of the double entry is: a number put onto your account balance at the bank. That's what they give. An asset comes in, a liability goes out. Neither were there before the loan event, and both are there after.

    Suddenly there's a lot of money in the world, because everybody is borrowing money from their bank, and the bank just invents it by using this method.

    Could credit also be issued by property developers to their customers? Could GM Financial do the same with cars? If they were receive an agreement to pay in exchange for something that costs them nothing to produce and deliver, or that in aggregate they don't have to deliver at all, then Yes. But the account balance the customers receive is the car itself, and they drive it away; it wasn't just a double-entry account-balancing event, largely left in the bank's customer account or the bank accounts of the aggregate of customers. Sure, yes, to some degree there is profit in the sale, and that percentage of the money seems to be invented, I think, but it's also kept in the seller's account rather than the customer's. So, no, I don't see how to do this without being a bank.
    So, in this way the banks actually create most of the money in the economy, according to their own profit-generating strategy. Therefore big banks, which mostly make enormous loans to enormous clients who make few jobs with their loan proceeds, lead to asset bubbles and general economic fragility, whereas small banks who make a lot more small loans to smaller companies, create a lot more jobs per dollar which also lead to more increases in economic production as distinct from asset price appreciation. In normal operations as well as banking crises, banks, and especially central banks, can simply create assets in the same way, by creating a loan/repayment accounting double entry, with the asset column being a repayment agreement with whoever, and the liability column being an invented amount of money theoretically used by that whoever as their money on deposit. Thus banking crises are more a way for central banks and large banks to manipulate the system for more power than a circumstance without a safe manageable resolution within the normal operations of banks. In short, support your local, small banks, and support the role of banks in supporting productive economic activity (loans to manufacturers not homeowners).

    But in the present environment of central banks running everything and making lots of loans for (not production-enhancing) financial asset transactions like buybacks and real estate purchases, it is clear enouugh that when the government prints a few trillion dollars, the prices in the whole stock and real estate markets 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 then all us turkeys, we all advise our advisers to follow their advice and direct the flow there, and algorithmically up it goes pushed with the pump of our pension contributions. 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 work for 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. So 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, Everyman, will certainly die in a race against this kind of steam shovel. 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 talk is about AI, but to me it's when rich sensors become part of the technology, that the playing field tips from humans toward tech.

    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 no-one 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. (Plumbing parts don't seem to be dropping in price much, though, so maybe this is a weak concept.) On the other hand 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 in 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 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, working people will certainly be paying rent somewhere, so some multiple of headcount times C class residential rents in today's money, tomorrow's 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 high tech new software economy, let them go into the forest and forage or starve, and with our 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 just drift downward.

    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, UBI, Universal Basic Income, 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 robot designers 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 its own 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 approximately zero would still 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). 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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    Modified: May 17, 2020.