In Gold They Trust

The illusion of black swan-proofing

It is easy to poke fun at those in Utah, and not just in Utah, who think that the road to safety is paved with gold. But much the same survivalist ideology shows up also in more financially sophisticated circles, in calls for greater “diversity and self-sufficiency”.

Here is none other than Gillian Tett, channeling Nassim Taleb, in a recent column:

“The mark of a truly advanced society … is to accept that pre-modern black swans can appear – and then create systems that can survive, even when our modern prediction techniques go wrong. Most notably, instead of building systems which are extremely interconnected, complex and opaque – which makes them liable to collapse if a shock hits – we could design simpler systems that could break into self-contained small units at a moment of disaster. Diversity and self-sufficiency, in other words, can prevent disastrous forms of contagion; or, as Taleb puts it, create a ‘black swan-proof world’.”

Taleb himself puts it even more strongly:

“Economic life should be definancialised. We should learn not to use markets as storehouses of value: they do not harbour the certainties that normal citizens require. Citizens should experience anxiety about their own businesses (which they control), not their investments (which they do not control).”

We could I suppose call this the “yeoman farmer illusion”, to emphasize the self-sufficiency dimension, but for present purposes I’ll call it the “outside money illusion”, to emphasize the dimension that contrasts most sharply with the money view.

From a money view perspective, my cash inflow is your cash outflow, and my financial asset is your financial debt. At the level of society as a whole, the fabric of current economic relations is knit together with a web of promises to pay in the future. Going forward, my ability to make good on the promises I have made to you depends not only on my own efforts, but also in part on the efforts of everyone who has made promises to me. And their performance depends in part on the efforts of all those who have made promises to them, and so on, and so forth.

From this perspective, financial assets are all inside assets, and as a general rule monetary assets are all inside assets as well. Gold is an exception, but apparently a terribly seductive one. The outside money illusion is the illusion that a de-centralized market economy could operate without a web of mutual promises, and interdependencies, to give it form and direction.

We live in a time of great uncertainty. During the crisis, private promises on which we depended, promises that were rated AAA by institutions we trusted, failed us. Government stepped in to prevent the larger web from unraveling completely, but at the cost of large and uncertain future liabilities, collective promises that we fear may constrain our future in ways we cannot yet see clearly.

Now, as always, the web of interlocking commitments is like a bridge we spin collectively out over the void toward shores not yet visible. The leading edge of our bridge has collapsed; the shore toward which we were spinning is now clearly beyond reach.

In the aftermath of crisis, we yearn for solid ground, for gold, for self-sufficiency. It is an understandable yearning, but it is an illusion.

Investment is an uncertain business because life is an uncertain business, and our demand for money is of a piece with our yearning for impossible certainty. The reality of inside money means that safety lies not in isolation and self-sufficiency, but rather in reconstruction of the web of mutual promises.

A certain amount of definancialization is inevitable in the short run; the leading edge of the bridge must be dismantled before we can begin to build again. But in the longer run the answer is not definancialization, but rather refinancialization, and on a more solid and robust basis than before.

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