The economy - a machine or an animal?

By Jeremy Hazlehurst

Last year Ray Dalio’s hedge fund made $13.8 billion (€10.5 billion). Since he launched the fund – which has the fist-pumping, Bon Jovi-soundtracked name of Bridgewater Pure Alpha - back in 1975 he has made $35.8 billion, making him the most successful hedge fund geezer ever.

As with all trading squillionaires, people want to know Dalio’s secret. Lucky for them, he has deigned to show his workings in a beautifully po-faced document that he calls his Template for Understanding. You can, if you are so inclined, find it on the fund’s website.

The first words are: “The economy is like a machine.” Clearly Dalio is brilliant at making money, but that’s a heck of an odd thing to say. Ask anybody who works for a real business if they think that the economy is like a machine, and they are likely to chortle, or start talking about wheels falling off.

This machine idea is probably a pretty common belief among the sort of people who gaze at graphs on screens all day – and such people seem to have an absurd importance in the modern world – so it’s worth pointing out why it’s wrong.

The economy-is-like-a-machine argument is reminiscent of the famous “watch on the beach” argument, dreamed up by 19th century theologian William Paley. He said that if you found a watch on a beach you would assume that it had been made by an intelligent designer because anything well-ordered and elegant must be the product of a guiding mind, ie God. The world is like a watch, he thought, neatly ticking along in perfect harmony, ergo it was made by God.

There’s a famous counterargument to this, by the Scottish thinker David Hume, and roughly paraphrased it is this: “WTF?” Hume thought it’s pretty eccentric to look at the world and think that it’s a beautifully constructed, elegant thing. Okay, some bits of it might be tickety-boo, but it’s also a pretty chaotic place, full of disease, war, mass extinctions, volcanoes, unpredictable weather, poverty and general nastiness. Hume said that the world looks more like a vegetable or an animal than a loom (looms were the height of technological snazz in his day, the iPad 3 of 18th century Midlothian).

Paley campaigned for the rights of women and the poor, so he can’t have thought that the world was that well-designed. He looked at the bits of the world that he thought are well-ordered and ignored the rest. Dalio is doing something similar. He predicted what would happen in some bits of the economy – the sub-prime fiasco and the eurozone comedy – and made a packet from them. But it doesn’t follow that all of the economy is predictable, like a machine is. Dalio admits that a third of his decisions go wrong. The machine is clearly not that mechanical.

Markets are a rag-bag of prejudices, poor decisions, biases, inefficient conventions, guess-work, stupidity, bets, luck, finger-crossing, irrational exuberance, animal spirits and the rest. They aren’t like bicycles or printing presses, no matter what hedge fund pin-ups say. Sometimes, occasionally, you might be able to predict something. But you shouldn’t get too carried away about it. As Hume might have said, markets are far more like animals. Maybe we sense that deep down – all the talk about bears and bulls is no accident.