The Confidence Game

You have to have the right attitude – that’s the only thing that matters. At least that’s what the conservative friend said a few years ago, as we were working on that third bottle of Tuscan red. Or maybe he said he was a libertarian – it was a long time ago. But his point seemed to be that with the right attitude one can become a great success, and nothing much else mattered. After all, Bill Gates was a college dropout and became one of the richest men in the world, and he ran down his list of other business giants who had even less education – they assumed they would be successful and thus were successful – and when they needed some specific detail handled, like when they needed a master lawyer or a brain-surgeon doctor or some such thing, they just hired some poor schmuck who had made the foolish choice of staying in school instead of conquering the world – you know, the hired help, like the gardener. And we drank some more of the excellent wine. And then he went off on all civil rights laws and interventions to level the playing field for minorities. He didn’t like such things – anyone with the right attitude could overcome adversities like being denied housing or education or a job or whatnot. If you had the right attitude you just worked your way around that stuff – you didn’t ask for favors, you just did. And he hated whiners. And he hated FDR and LBJ and people like that. They made his America a land of whiners.

But we decided to remind him of his career before he himself, also a college dropout, became CEO of his own software company. There were all those years as a studio guitarist here in Hollywood – a session player everyone called on to sight-read some nasty finger-busting passage and get it right on the first take – and his years as music director for this television show or that, and the film scores. Attitude is one thing, but could someone with a tin ear, no sense of rhythm and poor hand-eye coordination do what he did, with only the right attitude? He muttered something about the famous jazz guitarist Django Reinhardt and the fire that left the third and fourth fingers of his left hand paralyzed – you can overcome anything and Reinhardt, only eighteen when he was burned so badly, had the right attitude. But of course we argued back Reinhardt had real talent, and Reinhardt wasn’t overcoming having a tin ear, no sense of rhythm and poor hand-eye coordination. But you know the answer to that too – Reinhardt would have overcome those things too. Do you want to become a star NBA center? If you have the right attitude, even if you’re five foot two, you can be. Anyone can do anything. It’s confidence. It’s attitude. We create our own reality.

We were getting silly and of course then the conversation turned to the nature of reality, and things went even further downhill from there. That happens when you’re a bit tipsy and decide the nature of reality is endlessly fascinating. Someone quoted Einstein – “Reality is merely an illusion, albeit a very persistent one.” Everyone laughed, and we decided we had no idea what Einstein meant. And then someone remembered Lily Tomlin in her 1985 show, The Search for Signs of Intelligent Life in the Universe – “What is reality anyway! It’s nothing but a collective hunch.” We laughed again, but this time we got it. We were disagreeing in an odd way – about our hunches, and we had each decided our hunches were reality. There was no collective hunch.

But of course that meant there was no reality, because reality seems to be some sort of a social arrangement – everyone has to agree on what’s what. If no one agrees on some basics you get chaos, or gridlock. Money is like that – we all agree that those little green slips of paper have specific values and we all agree to pretend they’re valuable. But they’re just paper. And now we agree that electronic records of accumulations of such paper are just as good as the paper – we use our credit and debit cards and the banks tell us that we have specific assets and debits somewhere or other, which we never see, but make our life possible. We say that’s real money, but it’s an agreed upon fiction. We agree that’s reality.

And the financial system is like that. Let’s say that all that you’ve saved up for your retirement, in your 401(k) or whatever, shrank by seventy percent over the last three years, after all those years of growing and growing and growing. That’s about average for us all. Did you lose money? Well yes, and no. It was all hypothetical, and there was really no pot of money with your name on it stashed in some vault – it had all been pooled with other accounts and sliced and diced and invested and leveraged and reinvested and so on – your money was only an agreed upon fiction. Its fictional value went up, and then it went down. We just agree that’s reality. But the only time it’s real is when you tap it to retire to Akron or whatever. Until then it’s no more real than the Easter Bunny. What is the reality here?

And you say the value of your house has dropped thirty percent and now you owe more than it’s worth. If you still have a job and can easily make the mortgage payments and kind of like the place after all these years, are you in trouble? Yes, hypothetically – but only if you decide to sell the place. Then the reality of its value is an issue – other people are involved in an agreed upon reality – but, for now, its value can be measured by sitting on the back step and watching the kids play in the yard. That’s your reality. No one else is involved. The collective hunch doesn’t matter to you.

And markets are like that too. Day by day, hour by hour, and now millisecond by millisecond, people decide on the value of this and that – an ounce of gold or a hundred shares of British Petroleum or the exchange value of the euro to the dollar next month, in the futures market. It’s all a massive working out of collective hunches. Things are good, the markets soar – there’s a collective hunch that things will not go badly and the world is not a nasty place after all. The markets tank – there’s a collective hunch that the world is run by thieves and fools, and those in power are clueless, and there is not much anyone can do about it. Sometimes that hunch is quite general and sometimes tied to a market segment – airlines or the banks or discount retailers – or sometimes tied to a specific stock. The confidence is gone. You sell. Everyone sells. The bottom-feeders buy the stuff, betting the collective hunch is wrong, or thinking they’ll wait things out and one day whatever everyone is selling will turn around and they’ll be fat and happy – or they know someone even dumber than they are who will buy this crap from them within the hour. The whole thing is a confidence game, and maybe the guy who was once a studio guitarist was right – attitude is everything, and reality is what you make it. At least the markets work that way.

That is what the New York Times’ Ross Douthat was getting at with his column The Pessimism Bubble – we’re in trouble now because everyone has a collective hunch that the world is going to hell, and like fools we all talk to each other about it and make that so – the reality – when it isn’t so, or doesn’t have to be so. He seems to argue that reality is what we make it, and if we cheer up the reality will change. It’s a confidence game.

But he also mentions the market forecaster Robert Prechter doing his end of the world thing – we’re in for the biggest market drop in three hundred years and the Dow will settle at one thousand, for years, if we’re lucky, which he doubts we’ll be. Douthat doesn’t say Prechter is wrong, just that talk like that is dangerous. You don’t want to create that sort of reality.

But Douthat may be fighting a losing battle. A few hours after the Times posted his column, CNBC decided to run this story:

The Dow Jones Industrial Average is repeating a pattern that appeared just before markets fell during the Great Depression, Daryl Guppy, CEO at Guppytraders.com, told CNBC Monday.

“Those who don’t remember history are doomed to repeat it… there was a head and shoulders pattern that developed before the Depression in 1929, then with the recovery in 1930 we had another head and shoulders pattern that preceded a fall in the market, and in the current Dow situation we see an exact repeat of that environment,” Guppy said.

The Dow retreated 457.33 points, or 4.5 percent last week, to close at 9,686 Friday. Guppy said a Dow fall below 9,800 confirmed the head and shoulders pattern.

Okay, stop thinking about dandruff shampoo and guppies. This is serious. That’s some hunch about reality.

On the other hand there’s Steven Bainbridge – this guy – the William D. Warren Professor of Law at UCLA, where he teaches courses on corporations and business law. Bainbridge is a member of the Federalist Society – on the conservative right side of most everything, even if he didn’t have much use for George W. – and Bainbridge offers this:

Bullshit.

Repeat after me: Charting doesn’t work. Charts tell us nothing. Why? Because charting doesn’t work.

Charting does NOT work, because securities markets are weak-form efficient. The weak form of the Efficient Capital Market Hypothesis posits that all information concerning historical prices is fully reflected in the current price. Put another way, the weak form predicts that price changes in securities are random. Randomness does not mean that the stock market is like throwing darts at a dart board. Stock prices go up on good news and down on bad news. If a company announces a major oil find, all other things being equal, the stock price will go up. Randomness simply means that stock price movements are serially independent: future changes in price are independent of past changes. In other words, investors cannot profit by using past prices to predict future prices. Consistently, empirical studies have demonstrated that securities prices move randomly and, moreover, have shown that charting is not a long term profitable trading strategy.

Got that? No? If not, Bainbridge recommends Burton Malkiel’s Random Walk Down Wall Street. Who wouldn’t?

But the general idea is clear enough. Market behavior is random, and markets respond to those things that inspire confidence and those things that deflate confidence, so the reality is in the confidence game, not in any sort of historical pattern recognition crap.

But what is the collective hunch? There seems to be no agreement. It depends on where you sit. And say you’re sitting having lunch on what many say is the most beautiful boulevard in all of Europe, the Cours Mirabeau in Aix-en-Provence – Cézanne’s town. On a hot June day ten years ago it was impressive, and one tends to mellow out. And things look different from there, considering this Reuters dispatch from Aix:

Budget cuts and structural reforms will help cement Europe’s economic recovery, while bank stress tests will help restore confidence, the European Central Bank president, Jean-Claude Trichet, said Sunday. Mr. Trichet said he did “not believe at all” that Europe was facing a double-dip recession as markets took fright from weak data like the U.S. jobs report released Friday.

And this is why he thinks that:

Austerity drives and deficit cuts would not choke growth but rather restore confidence, he said. Mr. Trichet repeated his opposition to the idea of Europe-wide debt issuance to spur growth. “I have no positive view of such an idea. We are in a period where we have to manage very carefully all the budgets,” he said.

He said budget policies needed to be finely balanced to strengthen confidence.

So, knowing this is all one big confidence game, Trichet is of the mind that spending nothing on stimulus of any kind and cutting back on services, and letting people and business sink like stones, will inspire confidence in how the Euro-Zone countries are running things, as everyone will see that they will reduce their debt by any means possible, no matter what the consequences – and all will be well. This will inspire confidence. And confidence will conquer all.

Of course the Noble Prize economist Paul Krugman is having none of that:

You see, while traveling I reread Barbara Tuchman’s The Guns of August, and there it was: Plan XVII…

And that would be this:

Entirely offensive in nature, Plan XVII made extensive use of the belief in the mystical élan vital assumed to be instilled within every Frenchman – a fighting spirit capable of turning back any enemy by its sheer power.

Krugman:

Unfortunately, fighting spirit proved not very useful when charging machine guns. And I’m afraid that relying on confidence to deal with the downdraft from a financial crisis will work out no better.

Digby just calls it magical thinking:

Coincidentally, I recently re-read Guns of August as well and was struck by how much these martial cheerleaders reminded me of the famous Confederate belief that the south would win the Civil War because every southerner was worth 10 Union soldiers. This kind of magical thinking is fairly common, I’m guessing, among people who want to justify something they know doesn’t make any logical sense.

So she too is considering what she calls the Confidence Fairy, but realizes she was wrong to assume that the markets were talking about “confidence” in the sense of average Americans having confidence and being willing to spend and invest in themselves and their futures. That doesn’t seem to be the problem, and she cites this item from the Los Angeles Times:

In every recession over the last three decades, it has been America’s small businesses – those Lilliputian companies with fewer than 100 employees – that stepped forward, began hiring and pulled the country out of the mire. Not this time….

A host of factors – some well-recognized and others seemingly unnoticed in the national debate over economic policy – are converging to restrain small-business owners from hiring. Among them:

Near-stagnant demand for goods and services as a result of consumers’ reluctance to return to their free-spending ways -

A disturbing falloff in the creation of new small businesses -

The devastation of the real estate market -

Uncertainty about the economic outlook at home and abroad –

And this leads nowhere good:

The fact that many small firms are seeing little increase in demand for their services and products is decisive for Scott George, owner of Mid-America Dental & Hearing Center, which employs 55 people in the southwestern Missouri town of Mount Vernon.

“I’m not having any trouble getting money,” said George, who recently got a $250,000 loan to renovate one of his buildings. But he’s not hiring more workers because of little or no growth in sales.

And Digby adds this:

I don’t blame people for not spending. This is a tough downturn and the burden of debt left a lot of us hung over. But they aren’t going to come out of that very soon if they are continually being hammered with a drumbeat of apocalyptic talk about the deficit and calls for even more sacrifice and austerity. If you are an average person you see nothing but black clouds on the horizon, from terrorists lurking on every corner to suffocating fears of a health catastrophe to crippling national debt that will require you to work until the day you drop dead from exhaustion – and that’s if you’re lucky to have even a dead end job from which you cannot escape. What exactly is there to be “confident” about? Wealthy gasbags lecturing people to feel confident in the same breath that they calmly discuss the need for decades of austerity is a confidence fairy tale all right.

But then I thought about it and realized that this thinking is even more magical than I knew. It isn’t that these leaders think consumer confidence will save us – they don’t care about the real economy at all. Growth is solely a measure of elite confidence that their wealth will continue to grow. Somehow, these people have so completely sealed themselves in a bubble that they think that their ability to keep their game going is the only thing that matters. The real economy has become the fantasy and their arcane financial instruments have become the reality.

That means there are two confidence games to consider. And she adds this:

I don’t know what you do about this. It is irrational behavior and very difficult to counter. The global financial gamblers are unwilling to admit that the party’s over and so they are going to steal money from the average workers to keep it going for a while longer. The “confidence fairy” is nothing more than the desperate bravado of addicts trying to avoid hitting bottom – and taking everybody else with them.

But the idea is that austerity and widespread suffering and things shutting down do inspire confidence in the markets. See Fyodor Dostoevsky, Notes from the Underground – “The formula ‘two and two make five’ is not without its attractions.”

And somehow it’s all like that evening long ago with that former studio guitarist – a bunch of folks sitting around arguing about the nature of reality, when all it really is seems to be a collective hunch. But then all of life is a confidence game where all we have to decide is who we all agree should be the ones to fool us. And the markets will tank because we all know, really, that it’s all imaginary – confidence or lack of it, in what was never there at all.

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About Alan

The editor is a former systems manager for a large California-based HMO, and a former senior systems manager for Northrop, Hughes-Raytheon, Computer Sciences Corporation, Perot Systems and other such organizations. One position was managing the financial and payroll systems for a large hospital chain. And somewhere in there was a two-year stint in Canada running the systems shop at a General Motors locomotive factory - in London, Ontario. That explains Canadian matters scattered through these pages. Otherwise, think large-scale HR, payroll, financial and manufacturing systems. A résumé is available if you wish. The editor has a graduate degree in Eighteenth-Century British Literature from Duke University where he was a National Woodrow Wilson Fellow, and taught English and music in upstate New York in the seventies, and then in the early eighties moved to California and left teaching. The editor currently resides in Hollywood California, a block north of the Sunset Strip.
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2 Responses to The Confidence Game

  1. Rick says:

    Digby says:

    “I don’t blame people for not spending. This is a tough downturn and the burden of debt left a lot of us hung over. But they aren’t going to come out of that very soon if they are continually being hammered with a drumbeat of apocalyptic talk about the deficit and calls for even more sacrifice and austerity.”

    Hey, even Digby seems to believe in that “Confidence Fairy”.

    I’m thinking there’s no real question of “blaming” people for not spending, since so many of them — enough to create these statistics that tell us people haven’t been spending — have no money to spend. It may not be a choice for them.

    After all, if you have no job (and so many more people don’t these days), you have no money to spend. And if your unemployment benefits run out (so many more are now in that situation), you don’t have money to spend.

    Boy, for a persistent illusion, reality can certainly be hard for us to see some time.

    Rick

  2. katherine says:

    i dont know about confidence but i tend to be optimistic / my first rule re investing in the stock market is Dont Panic / smile / i will soon be 77 and i am in a race against time : will i outlive my money or will my money outlive me ? Either way works for me

    i am a great admirer of your posts / once upon a time i lived quite a bit above Sunset, actually above Mulholland and now i am in the land of the overwhelming sunset : SE Utah

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