The winner’s curse of IPL

Indian-Premier-League-IPL-logoThe auction of players in the Indian Premier League (IPL) T20 cricket tournament always throws up some interesting results. This time around, the auctions happened in early February and were no different from past years, with several uncapped players, who had played no international cricket and in some cases very little first class cricket, getting bought for a lot of money.

Take the case of Murugan Ashwin, a 25-year-old leg-spin bowler from Tamil Nadu, who had only played very few first class matches before the auction. His base price was Rs 10 lakh and he was finally picked up for a price of Rs 4.5 crore by the Rising Pune Supergiants team.

Why did someone with so little experience get picked up at such a high price? The recency effect was at work, with the recent performances of the players being given more weight by the team managements looking to pick up players. Ashiwn had performed very well in the Syed Mushtaq Ali trophy, which is the name of the domestic T20 competition, getting a wicket every fourteen balls.

The recency effect benefitted several other players as well. Rishabh Pant, the wicket-keeper of the India under-19 cricket team got sold for Rs 1.9 crore to the Delhi Daredevils team. His performances in the under-19 cricket world cup, was probably top of the mind recall for various cricket teams. Pant had smashed 78 runs in 24 balls, a few days before the auction happened.

In fact, in Ashwin’s case his performance in Syed Mushtaq Ali trophy was noticed by several scouts and this led to a bidding among teams driving up his price to Rs 4.5 crore. Scouts tend to be very confident about their choices and this bids up prices. It also leads to what economists call the winner’s curse.

As Richard Thaler writes in Misbehaving—The Making of Behavioural Economics: “When many bidders compete for the same object, the winner of the auction is often the bidder who most overvalues the object being sold. The same will be true for players.”

Thaler of course is not writing about cricket but American Football. But the logic applies equally to IPL as well. There were other cricketers also who benefitted from the winner’s curse. South African all-rounder Chris Morris, was sold for Rs 7 crore, after a bidding war erupted between Rising Pune Supergiants, Mumbai Indians and Kolkata Knight Riders. He was finally bought by Delhi Daredevils. His base price had been set at Rs 50 lakh.

Karun Nair who plays for Karnataka, also benefitted from multiple teams bidding for him. He was finally sold for Rs 4 crore, many times his base price of Rs 10 lakh. The same stood true for Rajasthan fast bowler Nathu Singh, who was sold for Rs 3.2 crore, many times his base price of Rs 10 lakh. Deepak Hooda’s price also went from his base price of Rs 10 lakh to Rs 4.2 crore, after multiple teams bid for him. Hooda plays as an all-rounder for the Baroda team in the domestic cricket competitions in India.

Not only the winner’s curse is at work, but there is something known as the false consensus effect at work, as well. And what is this effect? As Thaler writes: “Put basically, people tend to think other people share their preferences. For instance, when the iPhone was new I asked the students in my class two anonymous questions: do you own an iPhone, and what percentage of the class do you think owns an iPhone? Those who owned an iPhone thought that a majority of their classmates did as well, while those who didn’t thought iPhone ownership uncommon.”

Now how does this apply in case of auction of players? As Thaler writes: “When a team falls in love with a certain player they are just sure that every other team shares their view. They try to jump to the head of the line before any other team steals that guy.”

KC Cariappa who got bought for Rs 2.4 crore by Kolkata Knight Riders in the 2015 auction is an excellent example of the same. He was deemed to be a mystery player and the Kolkata Knight Riders team seemed to have fallen in love with him. In the process they bid up his price to Rs 2.4 crore, from a base price of Rs 10 lakh.

The thing is that many of these expensively priced players do not perform as well as the teams think they will. The winner’s curse takes its toll. An excellent example of this is Yuvraj Singh, who was bought for Rs 16 crore and Rs 14 crore respectively in 2015 and 2014, and did not deliver much bang for the buck.

As Thaler writes: “The winner’s curse says that those players will be good, but not as good as the teams picking them think.” Not surprisingly this time around Singh was finally sold at a much lower Rs 7 crore, to Sunrisers Hyderabad. Chances are this time he might perform better than the last two years.

The surprising thing is that it is not always performance that gets the money in IPL. Take the case of leg-spinner Pravin Tambe, who has bowled brilliantly over the last few years. In the 2016 auction he was sold to the Gujarat Lions for Rs 20 lakh. Given that he is 44, goes against him.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column originally appeared in the April 2016 issue of the Wealth Insight magazine.

The Wrong Causality

george cooper photo (2)

Vivek Kaul

Raghuram Rajan, the governor of the Reserve Bank of India (RBI), gave a spate of interviews to international publications in early August 2014. In these interviews he talked about the financial markets bubbles that have sprouted up all over the world, due to Western central banks printing a lot of money over the last six years.
In an interview to the Time magazine Rajan said that central bankers had constantly “infused liquidity into the markets” (basically printed money and pumped it into the financial system) in order to ensure that interest rates continue to remain low. The idea was that at low interest rates people would borrow and spend more money and this would lead to economic growth.
But that doesn’t seem to have happened. Instead a lot of this money has been borrowed at low interest rates and has found its way into financial markets all over the world. As Rajan told the Central Banking Journal “The problems arising are not so much from credit growth, which is relatively tepid in the industrial markets and has been much stronger in emerging markets, but from asset prices due to financial risk-taking and so on.”
With so much “easy money” floating in the financial system, investors have borrowed money at very low interest rates and invested them in financial markets all over the world. This has led to prices of financial assets (shares, bonds etc) being pushed way beyond their fundamentals justify.
Or to put in simple English financial markets through large parts of the world are now in a “bubble” (a word that central bankers do not like to use) phase.
This is something that economists who run central banks have refused to see. As Rajan put it “ Unfortunately, a number of macroeconomists have not fully learned the lessons of the great financial crisis. They still do not pay enough attention – en passant – to the financial sector. Financial sector crises are not as predictable. The risks build up until, wham, it hits you.”
The trouble is that no one really can predict when exactly will these bubbles burst. Rajan admitted to as much in an interview to the Financial Times when he said “the truth is, nobody really knows where the next one will come.” Nevertheless, when these bubbles start to burst, there will be trouble of the kind that the world experienced in 2008, all over again. As Rajan put it “We are taking a greater chance of having another crash at a time when the world is less capable of bearing the cost.”
The question is why has been there so much faith among economists when it comes to printing money. George Cooper explains this very well in his book Money, Blood and Revolution. As he writes “[The] monetarists economists believed the money supply controlled economic activity and therefore monitored it to measure and forecast economic activity. When they found that their forecasts were verified they naturally assumed that their thesis – money controls economic activity – was proven.” Hence, when the economy was not doing well, it made sense to crank up the printing presses, print more money, increase the money supply and get the economy going again all over again. QED.
This was the formula followed in the aftermath of the financial crisis that broke out in September 2008, with the investment bank Lehman Brothers going bust. Trillions of dollars, pounds, yen and renminbi, have been printed and pumped into the financial systems all over the world. This policy in central banking terminology has been referred to as quantitative easing.
The question is how effective has quantitative easing really been? As Cooper puts it “These policies have had, at best, mixed results so far. It is sobering to contemplate that all of this money may have been spent based on a basic misunderstanding of cause and effect.”
And what is this misunderstanding? Cooper explains this through an example of an economist who starts to study the number of trucks travelling on a motorway system. After having studied this for a while, it becomes obvious to the economist that there is a relationship between “the number of trucks travelling in a given period and the subsequent reported level of economic activity”. Hence, the economist draws the conclusion that road freight activity is a key driver of economic activity. So far so good.
This economist then goes on to found the freightist school of economics. The school then lobbies the government and policies that encourage the movement of trucks moving goods on the roads, are put in place.
Taxes are cut and schemes to subsidise the purchase and running of trucks are introduced. The first results of this experiment are positive as the economy grows. This leads to the government directly subsidising freight journeys. And this is where the problem starts. As Cooper puts it “Eventually truckers start driving freight up and down the country just to harvest subsidies. The economy stops growing but the freight statistics shoot through the roof. The relationship between economic activity and road freight breaks down.”
A basic mistake has been made here. “The freightist school has mistaken the direction of the causality between road freight and economic activity. Stronger economic activity causes more road freight but more road freight does not necessarily cause more economic activity,” writes Cooper.
A mistake along similar lines has been made by central banks all over the world, during the last few years. When economic activity picks up, money supply picks up as well. But that does not mean that the level of money supply can be manipulated to increase economic activity. As Cooper summarises it “Money is a measure of credit, and credit, like truck journeys, is created and destroyed according to the prevailing economic activity. Money supply, in its various forms, is an excellent measure of economic activity when left alone. But it cannot be used as an instrument to control the economy.”
In Cooper’s example we saw truck drivers driving freight up and down the country simply to harvest subsidies. Over the last six years, investors have worked along similar lines. They have borrowed money at very low interest rates and invested them in financial markets all over the world. And this has led to huge bubbles, which will burst in the years to come.

The column originally appeared in the Wealth Insight magazine for Sep 2014 

(Vivek Kaul is the author of Easy Money: Evolution of the Global Financial System to the Great Bubble Burst. He can be reached at [email protected])

The power of context

Vivek Kaul

We live in an era of instant coffee and analysis.
Even before something has happened, the analysis on why it has happened is ready. Given this, it leads to situations where we analyse using what we think is “common sense”.
But common sense does not always work. The simplest answer is not always the right one. Life can get a little more complicated than that.
Consider the story of a woman who the economists Abhijit V Banerjee and Esther Duflo met in the slums of Hyderabad. The economists recount this story in their book
Poor Economics-Rethinking Poverty & the Ways to End It: “A woman we met in a slum in Hyderabad told us that she had borrowed Rs 10,000 from Spandana and immediately deposited the proceeds of the loan in a savings bank account. Thus, she was paying a 24 percent annual interest rate to Spandana, while earning about 4 percent on her savings account.” Spandana is a micro-finance institution.
Common sense tells us that anyone in their right mind wouldn’t do anything like this. But the economists soon found out that there was a method to the madness, once they saw the context in which the woman was operating.
As they write: “When we asked her why this made sense, she explained that her daughter, now 16, would need to get married in about two years. That Rs 10,000 was the beginning of her dowry. When we asked why she had not opted to simply put the money she was paying to Spandana for the loan into her savings bank account directly every week, she explained that it was simply not possible: other things would keep coming up…The point, as we eventually figured out, is that the obligation to pay what you owe to Spandana – which is well enforced -imposes a discipline that the borrowers might not manage on their own.”
Once viewed in this context the story makes immense sense. The woman was borrowing at 24% and investing it at 4% in order to build a savings kitty for her daughter’s dowry. Of course,
prima facie this wouldn’t have seemed obvious at all. As Nicholas Epley writes in Mindwise: How We Understand What Others Think, Believe, Feel, and Want “The mistakes we make when reasoning about the minds of others all have the same central outcome: underestimating their complexity, depth, detail, and richness. When we’re indifferent to others, it’s easy to overlook their minds altogether, treating such people as relatively mindless animals or objects than as fully mindful persons.”
Epley gives a brilliant example of people who chose to stay back in in New Orleans when Hurricane Katrina hit the city in August 2005. The experts were at it with their instant analysis. As ABC News put it, “It’s hard to understand the mind-set of those who ignored evacuation orders.” Michael Chertoff, the Chief of Homeland Security said that those who stayed back made a “mistake on their part”. Psychiatrists suggested that there was a “certain amount of denial involved” on part of those who had chosen to stay back in New Orleans, given that they believed that they could handle the storm.
All these explanations sound pretty convincing, “but it does not resonate as well with the actual experience of most who left and stayed, because the broader context is not quite as easy to see.” It is simple to come to the conclusion that anyone choosing to stay back and take on a category 5 hurricane was not right in the head. But anyone who came to that conclusion ignored the context in which the people who had chosen to stay back, were operating.
As Epley writes “Compared to those who left, those who stayed were disproportionately poor, had geographically narrower social network, had larger families (both children and extended members), had less access to reliable news, and were considerably less likely to own a car.” And given this it was not easy for these people to just pack up and leave.
“If you had money to pay for an extended hotel stay, relatively small family to move, a car to get all of you there, or had far-away friends to stay with, you could
choose to leave. If you had no money for an extended hotel stay, no car to get you out, a large family to move and no long distance-friends to stay with, what choice did you have?” asks Epley.
Of course, people who analysed the situation did not understand this broader context. Given this, before passing judgements it is important to understand the context in which people are operating. People who chose to stay back when Katrina hit New Orleans, did not need convincing to leave the city, what they needed was a bus. As Epley puts it “Many who stayed wanted to desperately to leave but couldn’t. They didn’t need
convincing, they needed a bus.”
And what about the woman who borrowed money at 24% and invested it at 4%? What it clearly tells us is that there is a need for a savings solution which allows the poor to save on a daily basis. If they can discipline themselves to pay back micro-finance institutions every week, they can easily discipline themselves to save small amounts on a daily basis. Of course, there are financial institutions which cater to this market, but most of them are of dubious nature. Hence, there is a clear market out there for anyone who is willing to take the risk.

The article originally appeared in the Wealth Insight magazine August 2014

(Vivek Kaul is the author of Easy Money: Evolution of the Global Financial System to the Great Bubble Burst. He can be reached at [email protected])

The extortionate privilege of the dollar

3D chrome Dollar symbolVivek Kaul

On May 31, 2014, the total outstanding debt of the United States government stood at $17.52 trillion. The debt outstanding has gone up by $7.5 trillion, since the start of the financial crisis in September 2008. On September 30, 2008, the total debt outstanding had stood at $10.02 trillion.
In a normal situation as a country or an institution borrows more, the interest that investors demand tends to go up, as with more borrowing the chance of a default goes up. And given this increase in risk, a higher rate of interest needs to be offered to the investors.
But what has happened in the United States is exactly the opposite.
In September 2008, the average rate of interest that the United States government paid on its outstanding debt was 4.18%. In May 2014, this had fallen to 2.42%.
When the financial crisis broke out money started flowing into the United States, instead of flowing out of it. This was ironical given that the United States was the epicentre of the crisis. A lot of this money was invested in treasury bonds. The United States government issues treasury bonds to finance its fiscal deficit.
As Eswar S Prasad writes in The Dollar Trap—How the US Dollar Tightened Its Grip on Global Finance “From September to December 2008, U.S. securities markets had net capital inflows (inflows minus outflows) of half a trillion dollars…This was more than three times the total net inflows into U.S. securities markets in the first eight months of the year. The inflows largely went into government debt securities issued by the U.S. Treasury[i.e. treasury bonds].”
This trend has more or less continued since then. Money has continued to flow into treasury bonds, despite the fact that the outstanding debt of the United States has gone up at an astonishing pace. Between September 2008 and May 2014, the outstanding debt of the United States government went up by 75%.
The huge demand for treasury bonds has ensured that the American government can get away by paying a lower rate of interest on the bonds than it had in the past. In fact, foreign countries have continued to invest massive amounts of money into treasury bonds, as can be seen from the table.
foreign debt US
Between 2010 and 2012, the foreign countries bought around 43% of the debt issued by the United States government. In 2009, this number was slightly lower at 38.1%.
How do we explain this? As Prasad writes “The reason for this strange outcome is that the crisis has increased the demand for safe financial assets even as the supply of such assets from the rest of the world has shrunk, leaving the U.S. as the main provider.”
Large parts of Europe are in a worse situation than the United States and bonds of only countries like Austria, Germany, France, Netherlands etc, remain worth buying. But these bonds markets do not have the same kind of liquidity (being able to sell or buy a bond quickly) that the American bond market has. The same stands true for Japanese government bonds as well. “The stock of Japanese bonds is massive, but the amount of those bonds that are actively traded is small,” writes Prasad.
Also, there are not enough private sector securities being issued. Estimates made by the International Monetary Fund suggest that issuance of private sector securities globally fell from $3 trillion in 2007 to less than $750 billion in 2012. What has also not helped is the fact that things have changed in the United States as well. Before the crisis hit, bonds issued by the government sponsored enterprises Fannie Mae and Freddie Mac were considered as quasi government bonds. But after the financial mess these companies ended up in, they are no longer regarded as “equivalent to U.S. government debt in terms of safety”.
This explains one part of the puzzle. The foreign investors always have the option of keeping the dollars in their own vaults and not investing them in the United States. But the fact that they are investing means that they have faith that the American government will repay the money it has borrowed.
This “childlike faith of investors” goes against what history tells us. Most governments which end up with too much debt end up defaulting on it. Most countries which took part in the First World War and Second World War resorted to the printing press to pay off their huge debts. Between 1913 and 1950, inflation in France was greater than 13 percent per year, which means prices rose by a factor of 100. Germany had a rate of inflation of 17 percent, leading to prices rising by a factor of 300. The United States and Great Britain had a rate of inflation of around 3 percent per year. While that doesn’t sound much, even that led to prices rising by a factor of three1.
The inflation ensured that the value of the outstanding debt fell to very low levels. John Mauldin, an investment manager, explained this technique in a column he wrote in early 2011. If the Federal Reserve of the United States, the American central bank, printed so much money that the monetary base would go up to 9 quadrillion (one followed by fifteen zeroes) US dollars. In comparison to this the debt of $13 trillion (as it was the point of time the column was written) would be small change or around 0.14 percent of the monetary base
In fact, one of the rare occasions in history when a country did not default on its debt either by simply stopping to repay it or through inflation, was when Great Britain repaid its debt in the 19th century. The country had borrowed a lot to finance its war with the American revolutionaries and then the many wars with France in the Napoleonic era. The public debt of Great Britain was close to 100 percent of the GDP in the early 1770s. It rose to 200 percent of the GDP by the 1810s. It would take a century of budget surpluses run by the government for the level of debt to come down to a more manageable level of 30 percent of GDP. Budget surplus is a situation where the revenues of a government are greater than its expenditure3.
The point being that countries more often than not default on their debt once it gets to unmanageable levels. But foreign investors in treasury bonds who now own around $5.95 trillion worth of treasury bonds, did not seem to believe so, at least during the period 2009-2012. Why was that the case? One reason stems from the fact nearly $4.97 trillion worth of treasury bonds are intra-governmental holdings. These are investments made by various arms of the government in treasury bonds. This primarily includes social security trust funds. Over and above this around $4.5 trillion worth of treasury bonds are held by pension funds, mutual funds, financial institutions, state and local governments and households.
Hence, any hint of a default by the U.S. government is not going to go well with these set of investors. Also, a significant portion of this money belongs to retired people and those close to retirement. As Prasad puts it “Domestic holders of Treasury debt are potent voting and lobbying blocs. Older voters tend to have a high propensity to vote. Moreover, many of them live in crucial swing states like Florida and have a disproportionate bearing on the outcomes of U.S. presidential elections. Insurance companies as well as state and local governments would be clearly unhappy about an erosion of the value of their holdings. These groups have a lot of clout in Washington.”
Nevertheless, the United States government may decide to default on the part of its outstanding debt owned by the foreigners. There are two reasons why it is unlikely to do this, the foreign investors felt.
The United States government puts out a lot of data regarding the ownership of its treasury bonds. “But that information is based on surveys and other reporting tools, rather on registration of ownership or other direct tracking of bonds’ final ownership. The lack of definitive information about ultimate ownership of Treasury securities makes it technically very difficult for the U.S. government to selectively default on the portion of debt owned by foreigners,” writes Prasad.
Over and above this, the U.S. government is not legally allowed to discriminate between investors.
This explains to a large extent why foreign investors kept investing money in treasury bonds. But that changed in 2013. In 2013, the foreign countries bought only 19.6% of the treasury bonds sold in comparison to 43% they had bought between 2010 and 2012.
So, have the foreign financiers of America’s budget deficit started to get worried. As Adam Smith wrote in
The Wealth of Nations “When national debts have once been accumulated to a certain degree, there is scarce, I believe, a single instance of their having been fairly and completely paid. The liberation of the public revenue, if it has been brought about at all, has always been brought about by a bankruptcy; sometimes by an avowed one, but always by a real one, though frequently by a pretended payment [i.e., payment in an inflated or depreciated monetary unit].”
Have foreign countries investing in treasury bonds come around to this conclusion? Or what happened in 2013, will be reversed in 2014? There are no easy answers to these questions.
For a country like China which holds treasury bonds worth $1.27 trillion it doesn’t make sense to wake up one day and start selling these bonds. This will lead to falling prices and will hurt China also with the value of its foreign exchange reserves going down. As James Rickards writes in
The Death of Money “Chinese leaders realize that they have overinvested in U.S. -dollar-denominated assets[which includes the treasury bonds]l they also know they cannot divest those assets quickly.”
It is easy to see that the United States government has gone overboard when it comes to borrowing, but whether that will lead to foreign investors staying away from treasury bonds in the future, remains difficult to predict. As Prasad puts it “It is possible that we are on a sandpile that is just a few grains away from collapse. The dollar trap might one day end in a dollar crash. For all its logical allure, however, this scenario is not easy to lay out in a convincing way.”
Author Satyajit Das summarizes the situation well when he says “Former French Finance Minister Valery Giscard d’Estaing used the term “
exorbitant privilege” to describe American advantages deriving from the role of the dollar as a reserve currency and its central role in global trade. That privilege now is “extortionate.”” This extortionate privilege comes from the fact that “if not the dollar, and if not U.S. treasury debt, then what?” As things stand now, there is really not alternative to the dollar. The collapse of the dollar would also mean the collapse of the international financial system as it stands today. As James Rickards writes in The Death of Money “If confidence in the dollar is lost, no other currency stands to take its place as the world’s reserve currency…If it fails, the entire system fails with it, since the dollar and the system are one and the same.”

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The article appeared originally in the July 2014 issue of the Wealth Insight magazine

1T. Piketty, Capital in the Twenty-First Century(Cambridge, Massachusetts and London: The Belknap Press of Harvard University Press, 2014)

2 Mauldin, J. 2011. Inflation and Hyperinflation. March 10. Available at, Downloaded on June 23, 2012

3T. Piketty, Capital in the Twenty-First Century(Cambridge, Massachusetts and London: The Belknap Press of Harvard University Press, 2014)

Everybody loves a good story


 Vivek Kaul

I am writing this piece sometime in the middle of April 2014. The stock market in India has been on fire over the last one month, with the NSE Nifty and the BSE Sensex regularly touching new highs. Every time the market touches a new high, editors of newspapers/magazines/websites have to look for a new reason to explain the bull run.
Several reasons have been offered during the course of the last one month. First we were told that the stock market investors were betting on Narendra Modi becoming the Prime Minister. The numbers in this case didn’t really add up. The domestic institutional investors sold stocks worth Rs 13,130.77 crore during March 2014. Their selling continued in April as well. Till April 11, 2014, the domestic institutional investors had sold stocks worth Rs 3,728.06 crore. If these investors are really supporting Modi, then why are they selling out of the stock market?
Then we were told that the foreign investors were betting on Modi coming to power and setting the faltering Indian economy right. In this case, the numbers do add up. In March 2014, foreign institutional investors bought stocks worth Rs 25,376.45 crore. In April, the trend continued and by April 11, they had bought stocks worth Rs 3,658.21 crore.
But is the logic as simple as that? It is worth remembering here that the Western central banks have been running an “easy money” policy for a while now. The Federal Reserve of the United States, has been reducing the amount of money it has been printing since the beginning of the year. But at the same time it has reiterated time and again that short term interest rates will continue to be close to 0% in the near future.
Interestingly, the Fed repeated this in a statement released on March 19, 2014. The foreign institutional investors invested Rs 4,222.10 crore on March 21, 2014, in the Indian stock market. This is the highest amount they have invested on any single day, since the beginning of this year. So, are the foreign investors investing in India because they have faith in Modi? Or are they simply investing because “easy money” continues to be available to them at rock bottom interest rates? The stories appearing in the media haven’t got around to explaining that.
Another theory that went around briefly was that the stock market is rallying because India’s economic data had been improving. Inflation was down. Industrial output as measured by the index of industrial production had marginally improved. And the current account deficit had been brought under control. This theory lasted till the index of industrial production for the month of February 2014 was declared. Industrial output for the month was down 1.9%.
The conspiracy theorists also suggested that it was the black money of politicians coming back to India. They needed that money to fight elections. Well, if they needed that money, they would have sold their stock market holdings, and the stock market would have fallen. But that hasn’t really happened.
So what is happening here? As Ben Hunt writes in a newsletter titled Epsilon Theory and dated February 28, 2014 “Ants, bees, termites, and humans – the most successful species on the planet – are constantly signaling each other so that we can make sense of our world together. That’s the secret of our success as social animals.”
The point is that everybody loves a good story. We want coherent explanations of what is happening in the world around us. As Nassim Nicholas Taleb writes in The Black Swan—The Impact of the Highly Improbable “We love the tangible, the confirmation, the palpable, the real, the visible, the concrete, the known, the seen, the vivid, the visual, the social, the embedded, the emotionally laden, the salient, the stereotypical, the moving, the theatrical, the romanced, the cosmetic, the official…the lurid. Most of all we favour the narrated.
And this is where the media comes in, which tries to give us convincing explanations of what is happening in the world around us. Whether the reason behind a market movement is the real reason or not, does not really matter, as long as it sounds sensible enough. Taleb gives an excellent example of the same in The Black Swan.
“One day in December 2003, when Saddam Hussein was captured, Bloomberg News flashed the following headline at 13:01: U.S. TREASURIES RISE, HUSSEIN CAPTURE MAY NOT CURB TERRORISM,” Taleb writes.
Basically, what Bloomberg was saying was that the capture of Hussein will not curb terrorism and hence, investors had been selling out of other investments and buying the safe US government bonds, thus pushing up the price.
Around half an hour later, Bloomberg had a different headline. As Taleb writes “At 13:31 they issued the next bulletin: U.S.TREASURIES FALL: HUSSEIN CAPTURE BOOSTS ALLURE OF RISKY ASSETS.”
What had happened was that during a period of half an hour the price of the US government bonds had fluctuated. First they had risen as investors had bought the bonds. In half an hour’s time some selling had happened and the prices were falling. Bloomberg now told its readers that prices were falling because investors were selling out of US government bonds and looking at other investments given that with the capture of Hussein, the world was a much safer place.
Hunt offers a similar example in his newsletter. On November 28, 2008, Barack Obama, who had just been elected the President of the United States, appointed Tim Geithner, the President of the Federal Reserve Bank of New York, as his Treasury Secretary. The S&P 500, one of America’s premier stock market indices, rallied by about 6% on that day and Geithner’s nomination was deemed to be the major reason behind the same. As Hunt writes “All of the talking heads on the Sunday talk shows that weekend referenced the amazing impact that Geithner had on US markets, and this “fact” was prominently discussed in his confirmation hearings. Clearly this was a man beloved by Wall Street, whose mere presence at the economic policy helm would soothe and support global markets. Yeah, right.”
Geithner’s nomination was good news, but was it big enough to drive up the stock market up by 6% in a single day? As Hunt explains “So long as Obama didn’t nominate a raving Marxist I think it would have been a (small) positive development in the context of the collapsing world of November 2008. Was the specific nomination of specifically Tim Geithner WHY markets were up so much on November 24th? Of course not.”
The moral of the story is that first things happen and then people go looking for reasons. Hunt calls it “the power of why”. As he writes “It is the Power of Why, and it has no inherent connection to any true causal connection or the way the world truly works. Maybe it’s all true. Probably it’s partially true. But it really doesn’t matter one way or another.”
What is true of the financial markets in particular is also true for the world at large in general. As Taleb puts it “It happens all the time: a cause is proposed to make your swallow the news and make matters more concrete. After a candidate’s defeat in an election, you will be supplied with the “cause” of the voters’ disgruntlement. Any conceivable cause can do. The media, however, go to great lengths to make the process “thorough” with their armies of fact-checkers. It is as if they wanted to be wrong with infinite precision.”
So what is the way out? Taleb has an excellent suggestion in his book Fooled By Randomness—The Hidden Role of Chance in Life and in the Markets “To be competent, a journalist should view matters like a historian, and play down the value of the information he is providing, such as by saying “Today the market went up, but this information is not too relevant as it emanates mostly from noise.””
But that is easier said than done.

The article originally appeared in the May 2014 issue of the Wealth Insight magazine

 (Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected]