Wednesday, October 12, 2011

The Market’s Ineffability

John Paulson, the famous hedge fund owner who successfully shorted the housing market in the run up to the financial crisis, made some wrong bets recently. The economic recovery and inflation he anticipated have not happened. As the New York Times notes, his bet on gold was right for the wrong reasons. Gold rose, not because of inflation but because of chronic uncertainty. It is now falling. His Advantage fund is down $6 billion and many of his investors may decide to withdraw their money.  

One source of the market’s emotional appeal is its “ineffability,” the experience that we as traders and investors are subordinate to its judgment and its surprises.  Leo Melamed, the entrepreneurial engine behind the Chicago Mercantile exchange, the exchange that first introduced currency-futures trading, writes about the “beauty of markets.”  “But the important effect of trading is that it keeps me linked to reality and truth. The beauty of markets, and for me their quintessential characteristic, is that they are the final determinant of veracity. Washington policy makers, Tokyo or Berlin ministers, officials of governments the world over can try to tell the world whatever they want, but the markets tell the world the truth…their opinion doesn’t count a tinker’s dam unless or until it is endorsed by the market.” (Melamed, Escape to the Futures, 1996, p. 436).

It is easy to dismiss this as an exaggeration or a cover-up, but Paulson’s recent failure does suggest that the market’s truth can elude the most talented investor. One sees in this quote as well the pleasure associated with feelings of “awe.” The feeling of awe I suggest is derived from the self-organizing property of the markets, the fact that its logic is formed behind our backs and yet is built by our own hands. The pleasure we take in discovering self-organization is found in many places. People interested in group dynamics speak of the “music of groups," biologists are fascinated by the self-organizing dynamics of a bee colony, scientists by the logic and integrity of a natural ecology, legal philosophers by the evolution of common law, and even Marxists by the hidden hand of history. Awe emerges when we realize that despite our most purposeful efforts the logic of a self-organizing system takes us to destinations we never anticipated. No wonder critics of markets describe the love of markets as a kind of religious fundamentalism.

Perhaps this provides some insight into the rage people feel upon discovering that markets are fixed and manipulated. It represents an attack on our common and shared subordination to the truth and thus to our common fate. It is no longer the great equalizer. The resulting feelings of betrayal—the game has been rigged- may be more important than the anger at oversized compensation and unfairly distributed rewards.

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