65 Martin Place: Asylum for the Insane, or 20-Storey Logic-Bubble?

After having read quite a lot about mental models (or ‘mind-sets’, as Heuer calls them, or ‘logic bubbles’ as de Bono calls them), I’ve been persuaded by to believe that labelling another person’s beliefs or actions as ‘madness’ is an indicator not that the person in question is mad, but that one doesn’t understand that person’s reasoning nor agrees with their conclusions. My conclusion is an extension of de Bono’s conclusions regarding the labels stupid, bloody-minded and obstinate:

If someone does not agree with you or does not do what you think he ought to do there are several possible attitudes. He is stupid. He is bloody-minded. He is obstinate. There is, however, an alternative attitude: he is highly intelligent and acting intelligently within his own logic-bubble. And his logic-bubble happens to be different from yours. [Edward de Bono, Edward de Bono’s Thinking Course, p.83]

[As an aside, I find it puzzling that de Bono didn’t include madness in his list. It’s quite common for people to call each other mad. Perhaps he didn’t notice, or didn’t draw the same conclusion as me, or perhaps he was just being polite.]

This conclusion is useful, I think, and in an important way for us in our everyday thinking: 

  • it prevents one from succumbing to the natural and strong temptation to dismiss another person out of hand as a nutcase – that approach tends to be the end of all learning and the prelude to unnecessary and wasteful conflict;
  • it opens one up to exploring the other person’s reasoning and thus the chance of getting inside their mind-set / logic bubble;
  • it opens one up to the possibility that one is operating according to a flawed mind-set / logic bubble, and thus the opportunity to improve one’s own thinking, mental model, and (the all important) epistemic rationality.

So while the usual – and I think unavoidable – temptation when confronted with what looks like odd thinking and behaviour is to label it ‘mad’, the next step is not to move down the path of pronouncing this and condemning the other as a nut, but to choose the path of reflection, conversation and re-assessment.

Of course it is possible that the other person is round the twist, but, using a Bayesian framework, the probability of that outcome will I think be strongly influenced by the prior probability of their being insane. If you were visiting an asylum, the prior probability of madness that you would apply when judging the inmates would be quite high. If you were talking about an exalted and intellectually-serious financial institution such as the central bank, that probability would (I think) be quite low.

It was with this knowledge (or set of prejudices, if you disagree with me) that I read with interest excerpts from the latest column in the Australian Financial Review by the high-energy, high-IQ economist Chris Joye, regarding the Reserve Bank’s decision last week to lower the official cash rate by 25 basis points to 1.75% per annum:

Here’s the scary thing about the Reserve Bank of Australia’s decision to cut the cash rate to just 1.75 per cent. At a time of trend or better economic growth, historically low unemployment and soaring house prices, it’s 90 per cent confident that by the end of 2017, underlying inflation will be between 0.75 per cent and 3.25 per cent. That is, it has high conviction we could be experiencing either disinflation or inflation crises. Put more bluntly, the RBA has no idea.

Despite not being able to forecast the future, the RBA is punting that massively distorting the price of money and ensuing investment decisions in this way (funnelling unprecedented amounts of scarce capital and people into interest-rate sensitive sectors like residential and commercial property) will not damage the productive capacity of the economy or savers’ future standards of living.

When informed of the decision, one of the RBA’s staunchest and most respected media supporters bellowed: “They’ve lost the plot.”

Another long-time fan of Glenn Stevens who is a multi-billion-dollar hedge fund manager, called me days later saying: “These guys are mad – they’re blowing the mother-of-all property bubbles.” (We used the same words years ago.)

For what it’s worth, the RBA’s “90 per cent confidence intervals” around its 2017 forecasts for real economic growth and the job rate are, respectively, 1.0-4.5 per cent and 4.5-7.0 per cent. So the only thing our central bank can assertively say about next year is that the economy could be undergoing a mega-boom or bust. We would do no worse entrusting monetary policy to my five-year-old son, who as a maths savant has at least one edge over Martin Place’s mandarins.

Please note that Joye himself didn’t label the bankers as ‘mad’ or having lost the plot. However, he didn’t contradict his anonymous interlocutors, and the title of his essay is ‘The RBA has lost the plot’.

Now as it happens, I agree with Joye and his interlocutors that the Bank erred in reducing official interest rates last week. But it never occurred to me to label them as ‘mad’, or concluding that they had no idea. My initial thoughts, based on having thought about these things for many years, were:

  • that they had mis-read the inflation data, mistaking a change in relative prices caused by plunging oil prices for a reduction in the rate of inflation;
  • for the last 18 years, since the 1998 review of the consumer price index, the inflation data have been fatally flawed anyway, given that they mis-read house-price inflation with a bias to under-reporting inflation, so of course a result like this – cutting interest rates in the face of terrifying house-price inflation – was always possible and has actually been the default position of the Bank over that time;
  • the Bank’s model for understanding the interactions between economic behaviour, economic activity, inflation and interest rates is flawed, as it is in all other countries, as a result of the poverty and error of mainstream macroeconomic thinking, so that even if the inflation numbers were accurate the model would lead to policy errors in any case;
  • the Bank is trying to do an impossible job anyway, as central planning simply doesn’t work at any level and always leads to costly and wasteful misallocation of scarce resources*.

So on hearing the news I thought the Reserve Bank’s decision mistaken. But given that I think:

  • every central bank’s policy decisions can only be right by fluke anyway;
  • that the default position of central banks everywhere has since the financial crisis changed to propping up asset bubbles; and
  • that immense deflationary pressures generated by the world-historical misallocation of scarce resources over the past twenty years (itself a result of inevitable central bank policy errors) are leading central banks to imposing zero and now negative interest rates on their economies,

I saw it as being entirely consistent with everything it has done up until now anyway, and therefore only of interest to the extent that it confirmed to me the correctness of my decisions regarding the allocation of my own scarce financial resources.

So yes the Reserve Bank doesn’t know what it is doing. And it is blowing the mother-of-all property bubbles. But that’s not because the people at the Reserve Bank are mad, not by a long way: there’s no direct evidence of insanity among board members (that we know, anyway – they may all play dress ups and have food fights during the meetings, for all the minutes tell us), nor among the staff; there’s no indirect evidence, either, all the preposterous and mind-melting bubble-blowing notwithstanding.

The actions of the decision-makers at the Reserve Bank are instead most likely the result of their responding to the imperfect information that they receive in accordance with the mental models that they have used for so long and which haven’t yet failed them. The best response, I think, that we as outsiders can choose is not to dismiss them as mad, or having lost the plot, but to find out what that mental model is (it is likely spelt out in Reserve Bank press releases and publications, and in speeches made by Reserve Bank staff) and to interrogate it.

 *  *  *  *  *

Three other observations:

  • I think the staff at the Reserve Bank – at least the more senior ones, who understand what is happening and who know what is at stake – are terrified, both by what is happening – the confluence of intensifying disinflation and growing household indebtedness – and by a realisation that not only are they powerless to stop these developments, but that any and all manipulations of their only policy instrument now serve only to bring about the inevitable conclusion. They are out of options, and they know it, yet they, like the policymakers do with the budget in Canberra, go through the motions and hope that ‘something’ turns up. My suspicion – actually, my hope, given that I hope that the bureaucracy is aware of what is happening – is that the most recent policy decision was motivated not only by the recommendations of the mental models prevailing in the bank, but also by the fear that the economy is heading inexorably into debt-deflation. I could be mistaken – they may actually believe that the policy response is sufficient to restore ‘situation normal’. But given my belief in the fundamental sanity of the policymakers, I doubt it.
  • We have had before us, at least for the last fifteen years, the example of Japan’s fall into debt-deflation after the end of its bubble in 1989-90. A clear warning to all policymakers and especially central bankers to avoid making the same mistakes as were made in that remarkable but long-suffering country. And yet we’re going that way anyway. How to explain this? Possibly overoptimism – ‘It could never happen here’. But most likely because, while all concerned were aware of the long-term risk of ending up in the Japanese deflationary trap, at each point in time the policymakers were living in the present, and thus dealing with the exigencies of the moment. And so, through the process of imperceptible change moment-to-moment, by expertly solving the problems of those moments according to their lights and the information on which they deliberately chose to focus, the central bankers have placed us on a course for the place that all their actions were aimed at avoiding.
  • This sort of policy decision – the over-reaction to a favourable fall in the relative price of oil – is just the start. We have ZIRP, NIRP, QE, suppression of physical currency, and all of the other tools of financial repression to look forward to yet, all to be employed in maintaining the prices of property and securities at unimaginable and otherwise unsupportable levels, and all just prolonging the agony, intensifying the financial dislocation, and magnifying the scale of the eventual reversion to the mean. Imagine how Chris Joye and his friends will respond to those measures, if they think that a 25 basis point fall in interest rates is ‘mad’!

 *  *  *  *  *

* Joye also talks about this point (although he’s not as strong as me on this, nor, I think, as correct – see if you can spot the flaw in his argument):

The RBA’s mistake is buying into the global central-banking mantra that governments can do a better job of setting asset prices than markets.

This represents a bona-fide crisis of capitalism and the western liberal-democratic business model. After more than half a century of relying on freely-moving markets as the best decision-making device for signalling how resources should be allocated, we have thrown the baby out with the bathwater in our misguided desire to remove the downside. Central bankers now aspire to diversify away the business cycle through “nominal growth targeting”.

A stronger conclusion, created by a stronger argument, is I think contained in this excerpt from a recent essay by MN Gordon:

Earlier this week, Minneapolis Federal Reserve Bank President Neel Kashkari commentedthat U.S. interest rates are “about right.”  Moreover, Kashkari sees some real positives for society from the Fed’s loose monetary policies.

[I]t is Kashkari’s comment that interest rates are “about right” that’s saturated with the most conceit.  Does he know all?  Does he somehow possess the capacity to access and process all the bits of information that millions of buyers and sellers discern subjectively on daily basis?  If one man’s trash is another man’s treasure how can he possibly know what the correct price of anything should be?

Obviously, Kashkari cannot know this.  Neither can Fed Chair Yellen.  Nor the whole cadre of FOMC dot plotters.  Unquestionably, the cost of money is best left to consenting adults to determine on a transaction by transaction basis.

This, no doubt, is the fundamental shortcoming of today’s centrally planned monetary policies.  The consequences, however, are quite staggering.  They’ve pushed public and private debt well past their serviceable limits.  They’ve stretched paper currencies out like Silly Putty and propagated bubbles and busts in real estate, stock markets, emerging markets, mining, oil and gas, and just about every other market there is.

And, just for afters, this comment from financier Milton Berg:

They’re doing something that makes no sense with negative rates, but there’s so much credit in the system that just allowing people to borrow more money doesn’t really help the system. It just causes a greater bubble, which ultimately will deflate. It’s one big world-wide bubble, the central banks are all acting in unison, so once this bubble pricks it’s going to be pretty terrible.





About Stebbing Heuer

A person interested in exploring human perception, reasoning, judgement and deciding, and in promoting clear, effective thinking and the making of good decisions.
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