Maturization of Markets
Vol 15: Over Optimization, Financialization, & Specialization
As a brief forward, I want to thank everyone who reached out last week; as I mentioned in What I’m Here For, sharing that piece was nerve racking. I appreciated everyone’s support and feedback.
In a slight change of tenor, this past week’s geopolitical activity jolts us back to the fact that the Bretton Wood’s era is coming to a close, which means that the world we know is reorganizing itself, like deck of cards getting reshuffled. The question we should be asking is not who is reshuffling the deck, but what each of the players at the table will do with their new hands.
In the words of Tim Marshall, “this has happened before, it is happening now, and it will happen again.”
When I read this quote, I realized that this is just one of those natural cycles humanity has; in fact, the more I’ve read, the more I’ve realized that a lot of what we’re experiencing today isn’t really new, it’s just a new instance of what we’ve seen before. Changes happen, but the responses to the changes usually repeat.
For example, if we were to name a few of the challenges we see today — income inequality, loneliness, and the abdication of religion — we recognize that these are not new problems. But perhaps surprisingly, neither are periods of fraud, corruption, gambling (GameStop, NFTs, etc.), and even anti-tech rhetoric and policy. When you study history, you may remain surprised about what happens, but you’re less surprised about why it happened. Because as much as the world changes, people don’t. We’re virtually indistinguishable from humans from hundreds of thousands of years ago.1
With this in mind, it’s interesting to consider what really is new, and what will happen as a result.
In the next few Embers, we’re going to examine this very notion. What’s actually new, why, and what does that mean?
Over Optimization
Because the world order hasn’t changed much in the past 80 years, we’ve developed a societal Alzheimer’s towards the risks of over-optimization. I’ve been grappling with this idea for a while now.
The way the world works right now is not how it’s always been. But almost everything around us is built with very specific assumptions for how the world works and how it will continue to work. Most of society has successfully optimized itself for its respective goals. But with that optimization comes weakness. Even a seemingly small change is enough to destabilize it all.
COVID exposed a lot of this. Supply chains were unresilient, physical systems were open to sabotage, and legacy institutions struggled to maintain credibility. If anything, it showed us what was and wasn’t resilient, and we need to ask tough questions about what we want to do to change this.
But there’s another aspect to this maturization phenomenon that manifested itself much more clearly over the last 12 months: the capital markets.
Financialization
Every time the world order has changed, the financial system has changed too. Every world reshuffling has been accompanied by an equally significant financial revolution.
There are a few financial changes happening right now: crypto is an obvious one, but venture capital is increasingly getting institutionalized, to the point where I don’t think (most) people realize how different it will look in a decade.
But this is too granular, if we zoom out to look at this more broadly, we get a much more interesting image. Katherine Boyle, a venture capitalist, called this the Great Financialization: after the draft formally ended, the US started seeing significant bifurcation between private and public jobs. Pay used to be comparable, but not anymore. Katherine uses this as a lens to examine where ambitious people decide to work (in this particular case, she was talking about startups vs government). But I’m interested in something even bigger than that.
The 401(k)—the backbone savings vehicle of American retirement—did not exist until 1978. The Roth IRA was not born until 1998. If it were a person it would be barely old enough to drink. — Morgan Housel, The Psychology of Money
I frequently think about this, because it reminds me that the financial world we live in is new, and it has and will continue to change. Whether you realize it or not, the finance industry is playing an ever bigger role in our lives, regardless of our proximity to the capital markets. You might not care whether the Fed raises interest rates our not, but people in power do. And more and more people are invested in the markets, either through their own accord, or through pensions and index funds.
I lost track of how many Super Bowl ads tonight were focused on crypto, investing, and gambling. Part of that is the economic State of Affairs following the Great Recession, and part of that is that the world of finance matters that much more to today's society. And for understandable reasons.
Countries redesigned their entire economies based upon the Bretton Woods era, and they're entirely defendant upon the trade security and capital flows. US households hold a bigger share of their wealth in the stock market. China and Germany, on the other hand, have the biggest component of household wealth is housing. This makes the US economy more vulnerable to declines in the stock market, and China and Germany more vulnerable to declines in home prices. Pensions have a 7% investment return hurdle rate, but rates are at 1.5%. So they short volatility and we try to keep the system as stable as possible. This is why we bail out banks and hedge funds. Because they’re managing money for a firefighter who lives in California, and if the funds go under, then that firefighter loses his retirement. It's less about helping a financier (though that is a motivation), but moreso this is an example of ensuring the broader public doesn't get fleeced — they're the ones voting after all.2
The Fed said inflation was transitiory less so because they thought it so, but rather because they need to maintain the status quo. So much of the decision makers are focused on the public markets, that even if it may not resemble what the world’s economy actually looks like, it ends up impacting the economy, because that's how elites see it.
Markets are real in that prices are real, but they’re also not real because they’re gamed. — Howard Lindzon
Maturization
Over optimization and financialization aren’t necessarily new. I can think of many other historical examples. But the extent to which we've optimized and financially intertwined the world is new, and I don't see enough people talking about it.
When the optimization reaches a point where global stability becomes dependent upon Inherited Assumptions, you Maturize a system. It quite literally matured; it's fully developed, sitting at the most advanced stage, unable to evolve any further. And since it's mature, there's an established playbook, which means that people know how to play and game the system. Which begets heightened competition, which begets new strategies and tactics that will be included in even newer playbooks.
Leverage is a good term to use here. It’s not necessarily financial, though there is plenty of that (read: debt) already. This is more social, institutional, and systematic in nature. It's an insideous cycle, that compounds upon itself until you get to a point where a central bank can't raise interest rates too quickly, even in the face of inflation, because it can't risk inducing a global recession.
A few months ago, I read a tweet commenting on how oil was one of the most important thingw governing European football (soccer). The now deleted tweet said:
As usual, to understand what's happening with your favorite football clubs and the world's most famous football players you need a reasonably thick understanding of soft power competition between oil-rich gulf micro-states.
But it doesn't stop there. The fact that Ireland is a tax safe haven for companies is also a clear example of both globalization and Maturization. A country is literally deciding to retool it's entire tax system in order to curry foreign corporate favor. Even our domestic tax code is an example.
The fact that we need so many specialists illustrates that regardless of industry, society has Maturitized. We see this in markets, but it extends far beyond that. In athletics, youth programs and club teams are often called “feeder” programs. High school athletes are trained like horses, in an ever competitive college recruiting arms race. On the court, we see analytics beginning to drive all decisions, thanks to strategies like the ones employed in Moneyball.3 The fact that the NBA is now basically all 3-point shots and dunks — easily the two most exciting plays in the game — is proof of mathematics driving over-optimization.
The focus on getting kids into colleges, even outside of athletics, is an absurdly expansive and lucrative business. The fact that this can even be lucrative tells us a lot about today's State of Affairs. In a highly globalized and over-optimized world, you have to find a way to stand out. The rise of exam prep, essay writing help, and exotic community service expeditions are canaries in the coal mine.
These all illustrate 1) that the world is far more complex, complicated, and linked than we let ourselves believe, and 2) that by over-indexing on efficiency, the world has sacrificed flexibility in pursuit of consistency. And even without a comprehensive knowledge of physics, it's easy to observe that over time everything breaks down.
Yet even in the face of this change, we ensconce ourselves to these Inherited Assumptions, stultifying our growth and limiting our adaptability.
This is what happens when Maturization occurs. First, a rule of law emerges, and playbooks analyze and demystify them so the players in the system can navigate it effectively. After some time, global intertwining and playbook proliferation heighten completion. The biggest winners of a system then start to bend the rules to ensure status quo. Maybe this permits them to continue wielding their influence, other times it's because the system quite literally would collapse without total intervention. The end result is that the system and the people in it, for right or for wrong, are supremely devoted to the system’s continued survival, regardless of the merits of whether or not it should still exist. The institution isn't focused on its chartered goal, it cares about keeping the environment stable, because it know that if too many things change it will not survive.
What Now?
This isn’t meant to be a derisive commentary, so please forgive me if this comes off that way. It's rather an exploration of the world we're living in. I’m unsure if this Maturization phenomenon is a cultural one or an innate human one. It could be a bit of both, and I'm inclined to think that this type of institutional and societal decay is very much a part of some of the cycles I referenced at the beginning of this piece. It's very The Fourth Turning-esque.
In a sense, Maturization is the manifestation of the world that gave us the McDonald's Supersize option. Almost everything from markets to athletics have been Maturitized beyond the point of return. I’m interested in how resilient these systems are. Because change is coming, and a system's rigidity will tell us whether or not it will survive. March 2020 showed how Just-In-Time manufacturing is a dangerous form of leverage, one that is a liability in periods of uncertainty.
We’re an incredibly resilient species, so I’m not necessarily concerned about long term implications, but I do think much of society is ill-prepared for significant changes to how the world works.
Now, you would be astute in pointing out that every generation and culture before us has not been adequately prepared for these types of changes. I agree, but I also think it’s a noble goal to increase our appetite for resiliency. There’s ample room for redundancies in important institutions and infrastructure.
I want to be explicit that I’m not asking for widespread regulation. Instead, I’m advocating for more institutions to be robust and have plans in place in case things change, because when the world changes, you need to change with it.4
Humanity owes its existence to the fact that our mammalian ancestors took the opportunity to thrive when a meteorite smashed into the Earth millions of years ago. That's the mindset we need to embrace, a bias towards action and adaptability. If we don't, then we won't be able to survive this era's proverbial meteor impact. We know what happened to the dinosaurs.
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Maybe that’s also a useful reason why startups are so hard: making something truly novel is very rare, and willing it into existence fails to account for all the exogenous factors that must fall into place.
This is where things get a little murky. Some people get helped and others don't. The more cynical take is that Baby Boomers are still in power, long after they should've left public and private office. So policies and objectives reflect their interests. Politicians normally won't allow their own investments to dwindle if they can help it, but they especially won't tolerate that if their entire voting cohort would be impacted too. This ties to The Fourth Turning, demographics, and The Dictator's Handbook.
Don't misconstrue what I'm saying here: I love Moneyball and this idea of an orthogonal approach. I'm simply just highlighting that it now drives much of sports.
Maybe this is too naive, perhaps we should let institutions die off naturally. But if that's the right course of action, then we need to seriously start thinking about how we will make new ones that will replace them. Who will have input, what will the goals be, and how do we support people that need help as we transition to new systems?