The best thing I read this week was American Bandstand, by Ben Hunt of Salient Partners. It looks at the game theory and, more specifically, the “common knowledge game” and thus sees the market as more of a voting machine than a weighing machine, at least in the nearer-term. A taste follows, but it’s a long and carefully reasoned piece that you should read in its entirety.
The moment you give yourself over to the Dick Clarks of the world who create common knowledge, the moment you abdicate your keenly evolved human abilities of self-awareness and other-evaluation … that’s the moment you put yourself at the most risk. Because the game will change. Even if the external conditions of the world today are exactly the same as the external conditions of the world yesterday, a change in the internal conditions of the other game-players, whether it’s a queen bee like Draghi or a set of worker bees like us, can change your best move.
This is the insight that game theory provides, an insight that econometrics (which only looks at external conditions) can’t – how social dynamics and group interactions impact market behaviors. Game theory predicts that gold prices will go up on ANY news – even deflationary news – IF that news creates a worker bee perception that the queen bees are rattled by the news. And vice versa, gold will go down on ANY news – even inflationary news – IF that news improves the perception that global central banks are large and in charge … the Narrative of Central Bank Omnipotence. It’s not the news itself, which is what an econometric perspective would say, but how that news impacts the belief structures that comprise the game. It’s not the card that’s dealt (the news), but how that card fits the hand that your poker opponent is representing. An ace of spades is good news for your opponent in the abstract, but it might be terrible news if he’s representing a heart flush. Game theory is all about playing the player, not the cards. That’s not a replacement for understanding the fundamentals and the math of drawing this card or that, but it sure is a complementary skill set. If you want to win.