Author : John E. Charalambakis
Date : December 28, 2015
I boarded the non-stop flight from Cincinnati to Paris. Walking down the plane’s aisle I discovered a special area can accommodate round-the-table discussions, just as in previous years. To my left I saw Bacon, Descartes, and Heisenberg. On the right side were Kirzner, Byron, and Schaeffer. Inside me I was thinking how lucky I was to be in the company of such great people. Like in previous years, it was destined to be a wonderful ride and a lesson of a lifetime. The topic of this flight’s discussion had been chosen by no other than John Milton. The author of Paradise Lost wanted the group to discuss the investment process under current developments, eight years since the crisis of 2008.
Francis Bacon started the conversation by asking the group to assess the intellectual health of global developments. We understood his point since he wanted to raise the issue of rationality in a world characterized by disequilibrium. As a contemporary of Galileo, Bacon was known for his desire to inaugurate a new era in which natural science would bring a material redemption to humankind. Bacon wanted a new method of acquiring knowledge that would do away with prejudices, subjective distortions, and intellectual blindness. He wanted empirical experimentation to be the rule that will guide the mind to a higher understanding so that humankind can control its outcomes. Socrates – he argued – equated knowledge with virtue. “Now it was time to equate it with power too and show that history is not cyclical.” Progress, according to Bacon, required impatience with the methods of Aristotelian Scholastics so that through the inductive reasoning of concrete data empirically supported conclusions could be drawn.
“It’s obvious that Bacon has a problem with the deduction process and its premises” Heisenberg stated. He could probably see that Bacon had a point, especially if such deduction is dependent on premises of spurious concoction where funds are deployed according to preconceived notions that have nothing to do with reality. Heisenberg probably knew better than anyone in the group the uncertainty that arises when a priori beliefs make emotionally tainted investors trust deceptively attractive teleological forces. These kinds of forces are barren of empirical fruit, are rootless in terms of back-testing, and obscure the vision of investors, according to the uncertainty principle that took Heisenberg’s name.
Heisenberg did not want the discussion to revolve around his uncertainty principle, however he added: “Doesn’t it look like that with the unfolding of the QEs around the world since 2009 we all live in a grand theatrical production where the global monetary base keeps rising without any real increase in the collateral base, let alone any empirical evidence of the distortions they have created?”
“It seems to me that both Bacon and Heisenberg argue that higher returns and the much desired alpha are achievable when the investor’s mind is restored to an empirically-based process that takes into account not just prejudices but rather reason and trends,” Descartes added. “However, in an era where disrupting technologies like Google and Uber are disorienting the auto sector, then such Uberization of life creates an environment of skeptical relativism concerning the execution of traditional asset allocation models, especially when such allocations neglect risk parity considerations.” With little doubt the group understood Descartes. His point was that the epistemological uncertainty of his day – which coincided with the recovery of Sextus Empiricus’s classical defense of Skepticism – was pretty similar to today’s environment where investment choices lack anchors, neglect hedging, are blinded in terms of dormant assets, while managers’ obsess for diversification devoid of conviction and guided by deceptive presuppositions. The market’s residual confusions were evidence of an inefficient market according to Descartes. There are investment realities, Descartes believed, that can be exploited as long as investors do away with the presumptions related to the status quo. The Cartesian revolution (Cogito, ego sum) that he brought about was based on three distinct legs that encompass investment strategies: Skepticism, the use of mathematics, and the only datum that cannot be doubted, i.e. his own doubting, upon which rational choices are made and intuitions are built. “If something cannot proceed out of nothing, then an effect cannot possess a reality non-existent to its cause” Descartes declared to our group and made us all skeptical of the long term effects on wealth creation that can come out of the QE exercises.
“There are two realities” Israel Kirzner declared. “The first one is the res cogitans which reflects our thinking substance, our subjective experience, and our investment consciousness. The other is the res extensa which represents the objective reality and the extended substance of the market place.” The secret in long term investing is to identify the common underlying cause of both the cognitive capacity of human reason and the objective reality of a natural changing order that surrounds the imbalances, along with the enormous liabilities that securitization and credit overextension have created. Investors are nothing but human actors and entrepreneurs operating in an environment of inescapable uncertainty. The investors’ own existence and their strategies are owed to the finite unpredictability of the surrounding environment and to the ceaseless tides of change that undergird that finite unpredictability” Israel Kirzner declared while quoting Mises who once said that “entrepreneur means acting man in regard to the changes occurring in the data of the market.” We all understood Kirzner’s point on which he had elaborated before, that is rationality has limits not necessarily because of thoughtless actions but rather because the deliberation process of means-ends and costs-benefits was evolving and creative.
“Isn’t that the same argument you used with your Robinson Crusoe example years ago?” Francis Schaeffer asked. “That’s impressive” Kirzner replied. “I never expected anyone to make the connection”. “Yes, the entrepreneurial profit – like the alpha in investments – is identified only when Crusoe awakes in a self-awareness journey and discovers that he had erroneously misallocated his resources. Crusoe was wasting his time by trying to catch fish with his bare hands. When he came to the realization of his external environment and skepticism arose within him as to what else he could do, he decided to use his time to build a boat and make a net for fishing”.
Francis Schaeffer could not find a better opening for the point he wanted to make: Scope in life and in any human action is grounded in the possibility of discovering error within ourselves. “It is the discovery of discrepancy – a.k.a. mispricing in an inefficient market – that can make us better persons and investors as long as we are anchored on intrinsic values.”
“Where are you headed Schaeffer?” the other Francis asked. We knew that some tension was in the air. “There was a dangerous transition from Renaissance’s humanism to modern humanism” Schaeffer stated. “It was like Dante visiting hell without Virgil’s guidance.” The group got Schaeffer’s point that a value proposition rooted in a belief system where the center of gravity is fallible is destined to create hell. “You cannot paint the universal by observing the particulars. We all need to bring back to mind Raphael’s fresco in the Vatican, The School of Athens. Why do Aristotle and Plato point to opposite directions? What’s the meaning of that mispricing?”
“Furthermore” Schaeffer continued “we cannot accept the notion that the autonomy of the human reason can act as though the human mind is infinite with all knowledge within its realm. It is this misconception and the absence of a moral external anchor that created the mess in the French Revolution. Just compare and contrast the Bloodless Revolution in England in 1688 with the bloodbath that followed the French Revolution. The utopian dreams of a rootless humanism betrayed humankind’s potential.” Schaeffer’s point was echoing the group’s thought about investing without convictions, allocating portfolio risks according to how the wind blows, while recalling numerous baseless strategies absent of any rules simply because the managers fail to distinguish the market signals.
“The bottom fell out of the physicists’ world with the ascension of modern science, when a curved space finite yet unbounded emerged along with a four-dimensional space-time continuum” Heisenberg observed. We understood it to mean that the existence of fundamental fluctuations of energy in a total vacuum reinforced Karl Popper’s thesis that science can never produce knowledge that is certain given that scientific practice makes the governing paradigm self-validating and hence falsifications of existing theories are not probable. In a similar manner, the self-validating models of value at risk failed to have the foresights that could have helped them incorporate the reality that level three assets are nothing but algorithms that do not capture, let alone create, wealth, and thus the continuum of crises.
“That’s why we need the marriage of romanticism with science” Byron proclaimed. According to Byron the complex matrix of Renaissance, Reformation, and Enlightenment had put forth distinct streams of intellectual waves that revitalized and uplifted societies. One of them was stressing rationality, skepticism, and empiricism. The other was its polar complement and expressed itself by focusing on the human experience that was suppressed by the era’s overriding spirit of rationalism. This latter stream of intellectual wave could be found in Goethe, Schiller, Madame de Stael, Hugo, Pushkin, Carlyle, and Shelley. “The complex interplay of those streams of intellectual waves constitutes the modern sensibility. When the interlay is rough volatility rises and with that the finite unpredictability of the market moves to infinite uncertainty that transforms a stable disequilibrium into an unstable equilibrium.”
“That’s powerful” Kirzner said, and all nodded their heads. “Byron is telling us that Romanticism perceived the markets and the world as a unitary organism rather than as an atomistic machine. Romanticism affirmed the inexhaustible drama of human and market life rather than the calm predictability of static abstractions.”
It seems that we were arriving to some kind of consensus where the unequaled rational intellect and its power to exploit the unexplored needed a companion that could be found in the imaginative and spiritual realms that could uplift the emotional depths and creativity of the mind in order to reallocate resources for the discovery of dormant assets that could create wealth and move societies forward.
“Hi, Lord Byron do you recall your poem called Darkness?” a voice from the back of the plane was shouting. All of us were wondering if that plane’s section was bugged and all the passengers were overhearing our conversation. “Who is that?” Byron responded?
“It’s me, Abram Zimmerman, you know my son the poet/singer Bob Dylan. Those lines about men forgetting their passions and thus led into desolation were truly revealing. I taught my son about this while recalling the lynching in Duluth. You know that inspired him to write Desolation Row.”
As we were trying to recall the lyrics of Dylan’s song the pilot announced that we had to make an emergency landing in Iceland and the runway was known as Desolation Row. At that moment Harry Davison showed up out of nowhere looking for Aldrich and Warburg.
Happy New Year!