September 20, 2011
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This essay is excerpted from a recent version of The Credit Strategist (formerly the HCM Market Letter). To obtain the complete issue, you must subscribe directly to this publication; Please go here. The Credit Strategist is on Twitter - @credstrategist
“The cumulative accretion of knowledge by specialists that allows us each to consume more and more different things by each producing fewer and fewer is, I submit, the central story of humanity. Innovation changes the world but only because it aids the elaboration of the division of labor and encourages the division of time. Forget wars, religions, famines and poems for the moment. This is history’s greatest theme: the metastasis of exchange, specialization and the invention they have called forth, the ‘creation’ of time. The rational optimist invites you to stand back and look at your species differently, to see the grand enterprise of humanity that has progressed – with frequent setbacks - for 100,000 years. And then, when you have seen that, consider whether that enterprise is finished or if, as the optimist claims, it still has centuries and millennia to run. If, in fact, it might be about to accelerate to an unprecedented rate.”
August was the cruelest month, breeding losses out of the dead land of a weakening global economy. Stock markets suffered horrific losses: through August 26, the S&P 500 dropped by 9 percent while Germany’s DAX index dropped by 22.45 percent. Few other bourses in the world escaped without similar damage. Virtually every economic release revealed a slowing economy at risk of falling back into recession. Every major Wall Street firm sharply lowered its GDP estimates for the third and fourth quarters of 2011. The mood on Wall Street was somewhere between gloomy and desperate as computer-driven trading drove the markets to schizophrenic highs and lows. Moreover, the realization that many of the rallies and crashes that occurred during the month were driven by machines was at least as troubling as the decidedly downward direction of the market. There can be little question that investors are losing faith in the ability of the market to be a stable arbiter of values in the face of price swings that bear little relationship to company or economic fundamentals. This type of market action is decidedly hostile to capital formation and economic growth. The failure of regulators to address this issue is inflicting needless harm on both the markets and the economy.2
August’s threats weren’t limited to the manmade. Mother Nature also got into the act, inflicting a one-two punch on the East Coast of the United States - an earthquake and a hurricane. For those investors (usually quants) who like to explain away their losses by blaming them on 10th standard deviation events, here was a true statistical anomaly. TCS does not know whether any region in the modern era has ever been hit by both an earthquake and a hurricane in the same week, but the odds of such a combination have to be extremely low. TCS is waiting for the string of hedge funds trying to attribute their horrible August performance to these Acts of God.
I have recently been reading a book that I strongly recommend, Matt Ridley’s The Rational Optimist. Long-time readers may be surprised to see TCS recommend a book that finds the silver lining behind every cloud, but Mr. Ridley makes a compelling case that man’s fate lies largely in his own hands and that the collective efforts of mankind can conquer even the most severe challenges. He makes a compelling case that despite our current problems, the quality of human life today – even for the least privileged among us – is far superior to that of earlier generations. This, he believes, is the direct result of collaboration and innovation, two forces that heavily influence historical change. Moreover, Mr. Ridley views these processes as moral imperatives: “It is precisely because so much human betterment has been shown to be possible in recent centuries that the continuing imperfection of the world places a moral duty on humanity to allow economic evolution to continue. To prevent change, innovation and growth is to stand in the way of potential compassion.”3 In other words, we have a moral obligation to make the world a better place, and the most effective way to do that is by encouraging collaboration and innovation.
1. Matt Ridley, The Rational Optimist: How Prosperity Evolves (New York: Harper Perennial, 2011), p. 46.
2. About the only good news during the month was that the U.S. Congress was on vacation, rendering it impotent to inflict further manmade damage on the world.
3. Ridley, p. 28.
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