Catching crumbs from the market
The market is a collective intelligence that no one truly understands
One of my favourite articles of all time is ‘Catching Crumbs from the Table’ by Ted Chiang. Ted Chiang is a brilliant writer, whose work is perhaps categorised as a type of science fiction. In writing, he tends to change one small thing about our world and then work out all of the consequences. Inevitably, his world building is careful and immersive, and his stories are compelling. His most famous contribution is penning the novella or short story that inspired the film Arrival (2016).
‘Catching Crumbs from the Table’ is, I think, the only work of fiction ever published in Nature, one of science’s ‘big three’ journals. I recommend it to people all the time, and given my interests sometimes also have it recommended to me. Despite its short length, it gets across a realistic world in a very evocative way, expressing speculations that I think are almost entirely true, or at least as good predictions as you could plausibly make.
The story imagines a world where (friendly, well-aligned) artificial general intelligences have vastly surpassed human capacity for science. These AIs continually improve the technology we can use, in tangible ways that we experience when we use the advances. But we can’t understand how the advances have been made.
In a world where the frontier of science is so vastly far away from where humans had taken it, the most efficient way to do science is mostly not to theorise, experiment in labs, and so on, but just to take the data outputs the AIs make and try and decode them. How great is an AI really if it can’t explain what it’s doing to us? A reasonable question, but could we explain our reasoning to an ant?
I think this is an intriguing look at what might happen in a world with aligned AI. But this week, when markets in the UK have been going wild, it brought an idea to mind. Aren’t we already catching crumbs from the table?
According to the fundamental theorems of welfare economics, or Friedrich Hayek’s theories around information, market participants don’t need to know much to together interact and come to an efficient market price. Markets work because they take the tiny snippets of information the participants have and aggregate them together into something useful.
If the price is wrong, the market will pay you to correct it. The more it’s wrong, the more it’ll pay you. In a sense, entrepreneurs are people who notice some price has become wrong, perhaps due to a technological or social shift, and who set out to prove it. If they are right, they get rich.
This is all to say that markets are collective intelligences that may know more than you or I, or indeed any individual in the world.
In some extremely simple markets, it’s easy to tell what the market is telling you, and why. I was watching England play Pakistan on Sunday, in one of the best T20 games I’ve ever seen. Every time Liam Dawson hit a boundary in the England chase, the odds of an England win rose several percentage points, and the odds of a Pakistan win fell concomitantly. It’s obvious what was going on here. Each boundary was better than what was expected from the number eight, shifting the expectations bettors had about the future, and the prices they were willing to pay for contracts that pay out on different outcomes.
Some markets are a little harder to peer into. When house prices rise, the economist Scott Sumner might tell you not to reason from a price change, but if this happens just as we see a fall in interest rates, a rise in immigration, a fall in housing taxes, or promises to restrict the supply of housing, then we might feel reasonably confident in attributing the change.
Financial markets, however, can defy simple explanation. How about last Friday’s crash in the pound? It slid a little just before Kwasi Kwarteng went out to give his mini budget last week, then slipped another percentage point in the ten or so hours afterwards. Over the weekend the pound was obliterated in Asian markets, dropping nearly five percent on Sunday evening UK time.
Since then we have been catching crumbs from the table, attempting to explain this fall.
A handful of commentators, like Rishi Sunak, predicted ahead of time that there would be pressure on the pound under Liz Truss. But since she was, at the time, his rival in a Tory leadership election, and since, at that time, he was throwing everything he could at her, it seemed hard to put much faith in. Dominic Cummings tweeted in July that Liz Truss becoming leader meant ‘guaranteed fiasco’. But almost every recent UK prime minister has presided over quite a lot of fiasco. In both cases, standard forecasting rigour was not in place: it is extremely easy to predict downturns or generic bad happenings if you’re nonspecific about when they are going to happen and to what extent.
No commentators I have seen predicted at the time the budget happened, or immediately afterwards, that the pound would come under the sort of pressure it did. (Please correct me if I’m wrong.)
Since, we have been catching crumbs from the table. An intuitive argument might be that the fiscal event’s very significant spending commitments (from energy price caps) and tax cuts must have spooked the markets – perhaps Britain’s good credit is at issue. In fact, this argument seems so intuitive to people, that a great many have reached for it.
I believe, however, that our methods of catching crumbs from the table have moved on a little from this sort of reasoning. You don’t need to believe the most extreme and stringent version of rational expectations to think that the bulk of those commitments – which have been promised consistently for weeks or months – were already expected and priced in by the financial markets. Similarly, the sacking of Tom Scholar, which happened on 8th Sept, shortly before the pound peaked at $1.17, seems like an implausible reason that the pound fell on 23rd and 25th, given what we know about the forward-looking nature of markets. And, remember, that although the markets did react substantially to the announcements, the biggest drops came several days later.
A more plausible attempt at crumb-catching says that although only a few billion of the fiscal commitments were new information, these commitments were strong signals of the new Government lacking the commitment to fiscal rectitude that had until now been a hallmark of post-2010 big C Conservatism. This meant, in the medium to long run, UK financial assets had become riskier, perhaps because inflation has a chance of becoming unanchored. Underlining this might be the fact that the bigger collapse in the pound happened just after Kwasi Kwarteng went on Sunday television to promise even more tax cuts.
An alternative way of interpreting these crumbs – doing crumblinology – is to imagine you were a creditor to a struggling and mediocre firm which nonetheless sweated its assets as hard as possible to pay your interest and pay you back – but at the cost of attempting more high-risk strategies that might ultimately grow the company. If this firm attempted a radical new growth path, in part by focusing less on diverting all resources to paying your loan, you might be slightly worried – even if the high-risk strategies had a chance of working.
Some amusing crumb catching I have also seen takes a totally different line. The fiscal event will be good for the UK, this argument goes, except that the public (or press, and via them, the public) mistakenly hate it, and it will shift them towards voting for Labour. A rising chance of a Labour victory is bad for the pound for standard rational expectations reasons, this story goes. Though this would be a fun one to believe, and though there were indeed several polls showing gigantic poll leads for Labour, Betfair’s odds of Labour getting a majority at the next election, or the most seats, have barely shifted at all since Friday, so I suspect this one is not quite true.
Another option is to try and interrogate the price data we get with much greater rigour. Since gilt yields rose just as the pound fell, you might say that the pound might have fallen much further if the market didn’t expect the Bank of England to step in with higher policy interest rates. Things are actually worse than they seem! But then US and European government bond yields have risen at the same time (though less than those in the UK) so perhaps these are in substantial part international issues. Things are less bad than they seem!
Still, it is difficult to know. I certainly don’t pretend to have any idea which narrative is true, if any of these, I am far too ignorant about financial markets. The market’s view is not an average of the opinions of the inputs into it, but something entirely separate from any of them, a completely new view entirely. It is a black box, a superior collective intelligence whose motives and reasoning we can only reconstruct hypothetically.
We are already catching crumbs from the table, as indeed we were when Chiang wrote his story.