John Vachon Watchers October 1938 Cincinnati, Ohio. "Watching the sesquicentennial parade go by"

 

 

In the fields of economics and logic, there are basically two types of knowledge that can be communicated between people. The first one is usually through the use of indirect speech:

1) Individual Knowledge - X knows fact A and Y knows fact A, but neither necessarily know anything about the state of each others' knowledge.

e.g., X asks her dinner date, Y, if he would like to come upstairs to her apartment for a drink. Y is pretty sure he knows what’s really going on, but he doesn’t feel like having a drink and it’s possible that X is just being nice. X is pretty sure Y gets it, but it’s possible that Y is taking her offer at face value. The only thing they both know for sure is that X asked Y if he wanted to come up for a drink!

The second type is typically communicated through the use of very direct language:

2) Mutual Knowledge - X knows A, Y knows A, X knows that Y knows A and Y knows that X knows A (and X knows that Y knows X knows A, etc., etc.)

 

 

Mutual knowledge obviously has a huge influence on collective psychology and behavior in complex human systems, depending on the time and place in which this knowledge exerts itself. The Santa Fe Institute for Complexity Studies has recently made availble a video lecture by Alex Bentley, who has scientifically studied the role of "social influence and drift" in collective behavior. I highly recommend readers take a look at Bentley's lecture, which can be found here, but a brief summary will also suffice for the purposes of this article.

"Many explanations of human behavior – even among the 'social' sciences – start with people as isolated individuals, maximizing benefits versus costs. Panics or 'herding' events are often seen as anomalous departures from this norm. I would like to suggest that humans, whose very brains have evolved to handle social relations, are 'herding' much more often than commonly assumed

For a variety of modern phenomena,simple evolutionary models of social influence – or even just random copying – do remarkably well at capturing the large-scale dynamics of popular culture change

Such models offer an explanation for the often unpredictable flux of collective trends, especially in a modern society of unprecedented amount of choice and 'decision fatigue'. By then comparing to traditional societies, where both individual choice and social influence are often better informed, we can better understand how population scale data inform us about human decision-making and the dynamics of behavior change."

In the modern world of capital markets, this type of social influence and imitation provides the basis for mutual knowledge that can endogenously drive share prices higher or lower, as opposed to independent knowledge of a company’s “fundamentals” being the most significant factor in investment decisions.

e.g., Big-time Trader X tells big-time Trader Y that he and a few other big-time traders are fully invested in a certain stock with vast amounts of leverage, and big-time Trader Y imitates the leveraged investment.

So, while mutual knowledge can be a force that helps blow speculative bubbles amongst the herd, it can also be a force that incites mass resistance to oppression or even some form of revolution. Take the parable of The Emperor’s New Clothes by Hans Christian Andersen, for example. In that story, the child who pointed out that The Emperor "isn’t wearing anything at all" was not telling anyone a fact that they didn't already know.

Instead, his use of direct language alerted everyone to the fact that at least one other person, and most likely many other people, had thought the exact same thing about The Emperor – that he was completely naked. Once that mutual knowledge was established, it was used as a rallying point against the vain Emperor that intensified over time, until he was finally transformed into a more serious leader (a rather idealistic outcome when taken literally).

 

 

Still, that's the kind of mutual knowledge which builds a wealth of confidence in numbers, since people are more willing to speak/act out against those in positions of power when they can count on some level of support from others. And this is where the movements of our day find much of their core strength, whether we are talking about the “Arab Spring”, ongoing European demonstrations, mass civil disobedience such as the Occupy protests and strikes, local communities moving towards self-sufficiency or online communities fostering extensive discussion/action. 

Much of today’s popular protest momentum began with the Egyptian Revolution in January-February of 2011, where hundreds of thousands would gather in Tahir Square on a single day to peacefully express their disdain for the Mubarak government and years of economic oppression and inequality. Most of the population was already well aware of these injustices and the need for systemic change, but the act of gathering together in the Square catapulted their awareness into mutual recognition and, not very long after, Mubarak was forced to step down.

Although the Egyptians did not necessarily achieve their goals of socioeconomic redress and Mubarak was replaced with an even more oppressive military command, the presence they established in mass protest is still continuing on to this day, and not only in Egypt or the Arab region. The entire world had looked on and gained the mutual knowledge of popular resistance to oppression. Well within a year, the Arab Spring inspired protestors to amass in Liberty Square of Manhattan’s Financial District on September 17, 2011.

Again, this gathering wasn’t necessary to inform everyone present what they already knew about economic injustice and inequality; about how the supranational banks have been stealing wealth, destroying communities and ending lives and how the U.S. Government and Fed have been aiding them all the while. Some new facts are always being learned through these experiences, but the real value lies in the information being learned about each other.

The information that, not only are other people relatively awake and aware of what’s being done to them by the “1%”, but they are also willing to sacrifice their time, effort and, in some cases, physical safety towards the process of letting everyone else know who they are and where they stand. It’s a long and arduous process to be sure, and is by no means guaranteed to produce revolutionary results, but it does lay the necessary and mutual foundation for systemic change.

 

 

Since its inception in September 2011, the Occupy movement has established a presence in almost every major city in the Western world and some parts of Asia as well. Perhaps the most inspiring part of Occupy is that it so far shows no signs of repeating the mistakes of the European and American anti-capitalist resistance movements of the 1960s and 70s, which frequently used violent acts of terrorism to spread an otherwise valid message. The Occupy movement understands that, regardless of its intentions and ultimate goals, it cannot justify the use of violence against others, and that such violence will only undermine its ability to gain widespread support and be effective.

 

As a quick aside, let’s look to two of the earliest and most well known anti-capitalist activists in history – Karl Marx and Pierre-Joseph Proudhon. These two held a friendship for some years until a series of exchanges threw a bit of cold water on that intellectual fire. Marx sent Proudhon a letter inviting him to become a part of a correspondence network involving German, English and French socialists. Proudhon quickly sent a reply accepting the invitation with one very important caveat, which didn’t sit too well with Marx:

I have also some observations to make on this phrase of your letter: at the moment of action. Perhaps you still retain the opinion that no reform is at present possible without a coup de main, without what was formerly called a revolution and is really nothing but a shock. That opinion, which I understand, which I excuse, and would willingly discuss, having myself shared it for a long time, my most recent studies have made me abandon completely. I believe we have no need of it in order to succeed; and that consequently we should not put forward revolutionary action as a means of social reform, because that pretended means would simply be an appeal to force, to arbitrariness, in brief, a contradiction.

 I myself put the problem in this way: to bring about the return to society, by an economic combination, of the wealth which was withdrawn from society by another economic combination. In other words, through Political Economy to turn the theory of Property against Property in such a way as to engender what you German socialists call community and what I will limit myself for the moment to calling liberty or equality. But I believe that I know the means of solving this problem with only a short delay; I would therefore prefer to burn Property by a slow fire, rather than give it new strength by making a St Bartholomew’s night of the proprietors ...

Your very devoted Pierre-Joseph Proudhon

More recent philosophers/activists have also had their friendships divided along similar lines such as Jean-Paul Sartre and Albert Camus, with the fomer adopting a more hard-line Marxist revolutionary approach, while the latter is known for unequivocally stating that "the ends can never justify the means".

 

Our peaceful “protests” here at The Automatic Earth and on many other websites/forums are also rooted in both increasing factual knowledge and mutual knowledge. We all have different styles, perspectives, opinions, areas of expertise and general predictions, but we are mutually driven, like Marx and Proudhon, by our desire to see others opt out of the current exploitative system, take back control over their own lives and provide moral and/or physical support to families, friends, neighbors, communities and complete strangers.

Our very own Nicole Foss provides an invaluable service in this regard, as she has tirelessly traveled between communities in Europe and North America relaying TAE’s message to groups of people with varying perspectives and levels of knowledge, but all with the common yearning to know that they are not alone in this journey. The TAE Community, in general, has fostered mutual knowledge of our financial, economic, energy and environmental predicaments for many years now through the comment section.

 

Statistics for The Automatic Earth (at Blogger)

 

 

Those steadily increasing bars you see from 2008-2011 are representative of increasing mutual knowledge. Every new person that decides to “join” the community is gradually welcomed by the mutual knowledge that thousands of others are also joining or are still here. The exact numbers have been scrubbed for privacy reasons, but I can assure you that they are not insignificant. They possess just as much revolutionary potential as the movements taking place “on the streets”, as both types feed into each other and promote mutual awareness of the possibilities for change.

None of this is to say that the strategies or movements towards mutual knowledge are perfect, and some may have very significant shortcomings. As mentioned above, we would do well to dismiss any movement that actively promotes violence as a means of achieving its goals, because such strategies are both unethical and counter-productive. There is also some harm from “going all in” on these movements and using them as justifications to avoid conducting our own preparations at much smaller scales.

That risk is more pronounced with OWS than with an online community such as TAE, since the latter focuses on promoting understanding of these risks as well as a high degree of systemic independence and self-sufficiency. There is always the lingering fear that those solely relying on OWS, on the other hand, will find themselves lacking the personalized preparation that is necessary to weather upcoming storms.

That is why we must constantly balance our movements of mutual knowledge and struggle with our independent awareness of what is happening within our own lives and those of our families, friends and neighbors. Or, as Raul advised, Occupy Your Own Space. We must be conservative, vigilant and broadly revolutionary all at the same time. It is with this balance that we will all continue to mutually stray from the beaten path and discover our own trails into the future.

National Photo Co. Bond Vault 1914 "Treasury Department, Office of Comptroller of Currency -- bond vault. Contains bonds to the value of $900 million securing government deposits and postal savings fund"

 

I’m not a technical analyst or a fundamental analyst or any other type of equity market analyst. What I am is just a guy who likes to think he can spot completely nonsensical propaganda when he reads or hears it. You know, the type of non-stop propaganda that attempts to manage perceptions/expectations and convince "investors" that, while things are obviously very bad in the real economy, everything is still just hunky dory in the wonderful world of equities. Case In Point Some mainstream market analysts chimed in after the serial S&P ratings downgrades of nine Eurozone countries, and specifically the one-notch downgrade of France from AAA to AA+ (ratings outlook still negative), to say that the market had already "priced them in" and therefore they are really no big deal. S&P had put all of these countries on negative watch back in December before the latest and unsurprisingly innocuous EU Summit, so the downgrades were no surprise. Here are just two examples of a very pervasive and perverse logic, presented by The Telegraph:

S&P cuts ratings of nine eurozone countries: reaction Fabrice Seiman, head of Lutetia Capital, said: "S&P is absolutely right. France is paying the price of 30 years of irresponsibility in public finances. French politicians on the right and on the left fell short of the job by not taking measures to reduce  spending." I think this is already priced in. There should not be any sizable reaction, but there could be a technical reaction on the Franco-German spread. It should be limited to the long-term and if there is a reduction in spending." Bill O'Grady, chief market strategist at Confluence Investment Management, said: "If France had been downgraded more than one level it would have precipitated a crisis. This is not good but it was anticipated, baked in. For oil it is probably a neutral event. If it raises concerns about a worsening economic environment it would be bearish."

Ashvin: That logic does sound appealing on the surface and many others like to parrot it, but the first question to pop into my mind was this – how can the market "price in" very significant developments in Euro sovereign credit markets by steadily increasing in valuation since they became aware those developments would occur?? Since the S&P put a bunch of EZ countries on negative watch on December 5, 2011 and the EU Summit on December 9, the S&P500 has risen almost 6%.

 

 

That’s a boat load of downgrades the market appears to have priced in over the last month while very little "positive" news has come out of Europe. Now I’m confident that the initial reaction to my question above would be, "that’s a really simple and stupid question to ask!". Fortunately, there are several great analysts out there who have reached similar conclusions about these equity markets, which have allegedly "priced in" everything under the Sun, and have provided us with slightly more nuanced arguments than my own. The U.S. Dollar (and Treasuries) has been increasing in value alongside U.S. equities, so the pundits should find it very difficult to explain the upwards "pricing in" market action of the last month by saying it is a nominal increase of shares priced in dollars. What we have is a very significant divergence between the dollar index and equities, as Charles Hugh Smith outlines in his piece, A Useful Fiction: Everybody Loves a Melt-Up Stock Market, and one that must close in the near future. The following charts of the dollar index ($DXY) and 5-year Treasuries are from M3 Financial Analysis:

 

 

 

The truth is that the very notion of the market "pricing in" events as the investor collective becomes aware of them is flawed. In the comprehensive TAE classic of 2010, Fractal Adaptive Cycles in Natural and Human Systems, Nicole Foss delves into Robert Prechter's theory of "Socionomics" (among other things) and how it can explain market valuations as a function of endogenous factors, such as the collective mood of investors, rather than exogenous events relayed by "the news".

Bob Prechter's socionomics model combines Elliott's observed fractal patterns with an understanding of human herding behaviour, comprising a comprehensive challenge to prevailing notions such as the Efficient Market Hypothesis by reversing causation and recognizing the role of emotional/irrational behaviour as the prime market driver. While the real economy demonstrates negative feedback loops, finance is thoroughly grounded in positive feedback.

Ashvin: Mish Shedlock also touched on this concept in a post earlier this week. He illustrated that, at best, the market should be viewed as a contrarian indicator for future economic trends due to its function as a gauge of extreme sentiments, and, at worst, it shouldn't be viewed as an indicator of anything at all.  

Cherry Picking Timeframes on Alleged Leading Indicators; Big Change In LEI on January 26 "The stock market is not a leading indicator of the economy. Rather, the stock market is a coincident indicator of sentiment towards equities. ... Far from being a leading indicator, on an absolute basis the S&P has a perfect track record of peaking right before or just as a recession starts. This is just as one might expect from a gauge of equity sentiment which tends to peak right before a downturn in the economy (with everyone extrapolating good times forever into the future).     ... On a percentage change basis, the S&P 500 is not leading, not lagging, and not coincident. Instead it is completely useless mush."  

 

Ashvin: It's not just the "fringe bloggers" drawing these conclusions about the market, but also such "reputable" financial institutions as UBS. Granted, the well-intentioned bankers over there also point out that the French downgrade, among others, was expected and shouldn't affect near-term credit spreads too much. Instead, they choose to focus on the effects it will have on the state of realpolitik in Europe’s core, and how that is certainly not something which is "priced in" at all. Indeed, only market shills and fools can even pretend to separate the two (finance and politics).

 

UBS Explains Why AAA-Loss Is Actually Relevant

"France has not only lost its AAA status. Critically, France has lost AAA status at a time when Germany has not. France also retains a negative outlook against a stable outlook for Germany, compounding the distinction. The relative decline of France’s credit rating is something that has potential political implications. There are parallels here to the relative positions of the UK and the US in 1949, in the wake of sterling’s devaluation against the dollar. The devaluation was simply a confirmation of economic reality, but the visible confirmation of that shift in relative economic reality served as a defining moment in the shift of the bilateral relationship in political terms. Since the foundation of the Coal and Steel Community in 1951, the history of (continental) European politics has been essentially a story of France and Germany holding each other in check. Indeed, this was the explicit aim of the ECSC’s founders. With the downgrading of France relative to Germany, there is now a de jure as well as a de facto inequality between the two states. The ability of France to act as a counterbalance to Germany in economic decision-making has been compromised. In the wake of the downgrade of the EFSF, it is clear that the actions of S&P have elevated the role of Germany (and perhaps, to a lesser degree, the Netherlands) in any collective economic decisions within the Euro area. Any economic decision that requires money to be spent will require wholehearted German endorsement if rating agency determined credit credibility is to be maintained. The bargaining power of Germany in the economic councils of Europe has been correspondingly increased."

 

Ashvin: So if the equity markets are "pricing in" anything, it's the pure hope that all of these downgrades of countries, banks and corporations will continue to be glossed over by bond markets, that political/economic imbalances in Europe haven't been exacerbated, that the Greek government and its creditors aren't helplessly struggling to reach a "voluntary" debt reduction deal before a technical default in March becomes inevitable, that China/India aren't facing "hard landings" and that the U.S./U.K. economies will not be dragged down by their own housing markets, corporate [lack of] earnings, unemployment trends or any of the above. Some people will tell you that the only thing the markets need to keep their manic phase intact is the inevitable QE money printing that the Fed will officially announce, which has conveniently been "just around the corner" for almost a year now. Despite those consistent predictions of QE3, I made clear that I didn’t expect the Fed to relent in 2011, and many of the same financial and political reasons underlying that expectation still stand. The primary reasons being the conundrum reflected by the fact that the S&P is still hovering around 1300 (and oil around $100/bbl), which makes the marginal benefits of QE very slim, and the politically volatile situation in the run-up to November’s elections. On the other hand, the financial threats from the Euro crisis and a strong dollar (weak euro) have clearly intensified over the last few months, and the ECB is even more constricted from printing than it has ever been (at least for anything other than sub 3-year sovereign paper through its indirect LTRO, which still doesn’t reflect net cash entering EZ bond markets). Perhaps these developments will finally convince the Fed to "pull the trigger" on QE3, but then many questions still remain – how many trillions are needed to boost "risk appetite" for more than a few weeks and what happens when those trillions are perceived as "not enough"? Like I said at the beginning, I'm not any sort of market analyst, but there do seem to be a whole slew of developments starting to weigh on collective investor sentiment right now, which will only get heavier in the upcoming weeks and months. No one can tell you that any of these negative and ongoing developments herald an imminent market crash or how exactly they will impact shares. What I can say with confidence, though, is that none of them are insignificant bumps in the road. They certainly did not "remove any uncertainty" from the markets and they have in no meaningful way been "priced in" by these markets either.