Posts Tagged ‘finance’
“We cannot reason ourselves out of our basic irrationality. All we can do is to learn the art of being irrational in a reasonable way.”*…
Classical economists posit that investment decisions are driven by rationality — a clear-eyed evaluation of risks and rewards… but then, meme stocks.
Kwabena Donkor, an assistant professor of marketing at Stanford Graduate School of Business has just unveiled some new research that suggests that identity distorts our financial choices, leading us to overvalue investments that reinforce our sense of self…
People don’t just invest with their wallets — they invest with their identity,” says Donkor, a faculty fellow at the Stanford Institute for Economic Policy Research.
In a novel field study involving soccer fans, Donkor and several colleagues uncover evidence of how identity can skew economic thinking. The researchers ran a series of experiments focused on fans who placed nearly 40,000 bets on English Premier League matches during the 2021-22 season. Participants — nearly 800 from Kenya and 1,600 from the United Kingdom — were given a budget and asked to place bets on upcoming matches. They received winnings based on the outcomes of randomly selected games.
Most of the participants were longtime supporters of a particular team. (Manchester United was their top favorite.) They were more optimistic about their favorite teams, betting 20% more on them. They rated their teams as having a 10% to 18% higher chance of victory than other teams, even when presented with forecasts from professional oddsmakers suggesting otherwise. These results persisted even after accounting for factors such as personal beliefs and appetite for risk.
The study also finds that participants placed a lower value on gains not aligned with their identity — what the researchers referred to as an “identity tax.” Fans effectively devalued these neutral bets by 17% to 27%. For poorly performing teams, this “tax” could soar as high as 47%, reflecting a strong emotional impulse to support their favorite team even when the odds were against it
The research, detailed in a paper cowritten with Lorenz Goette of the National University of Singapore, Maximilian Müller of the Toulouse School of Economics, Eugen Dimant of the University of Pennsylvania, and Michael Kurschilgen of UniDistance Suisse, shows that identity-driven preferences explain much of the gap in bettors’ behavior. Simulations showed that distorted beliefs due to identity account for as much as 44% of the difference in fans’ betting behavior. The remainder stemmed from preferences rooted in identity itself — people were willing to sacrifice potential gains to support options that aligned with who they are…
… The study’s findings have far-reaching implications for understanding economic behavior, particularly in areas like consumer finance, brand loyalty, and even political decision-making…
… the research hints at how consumers view different products. Items that align with a person’s identity are likely to be seen as complements rather than substitutes. For example, Donkor says a consumer who identifies strongly with sustainability might view eco-friendly products as essential enhancements to their lifestyle, even if they’re similar to comparable, less expensive goods.
Ultimately, these findings could improve our thinking about the biases that influence our financial lives. As the researchers point out, acknowledging the role of identity in decision-making is one key to designing better policies, creating more effective financial products, and ultimately improving individual welfare. “If we ignore identity,” Donkor concludes, “we miss the bigger picture in decision-making.”…
Understanding the choices that we, and those around us, make: “What Soccer Fans Can Teach Us About Making Irrational Decisions,” from @SIEPR.
* Aldous Huxley
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As we ponder the price (and as a reminder that there are other kinds of irrational decisions and that sometimes returns do matter to investors), we might recall that it was on this date in 2008 that Bernard “Bernie” Madoff was arrested and charged with defrauding investment clients of as much as $65 billion. A pioneer in electronic trading and chairman of the Nasdaq stock exchange in the early 1990s, he had turned to money management. By 2008, Madoff was running a huge and growing fund that promised its investors high and stable returns… the problem: it was a Ponzi scheme, the largest known Ponzi scheme in history.
“Wealth does not consist in money or in gold and silver, but in what money purchases”*…
For millennia, simple forms of record-keeping have been used as ways to keep track of debt, to substitute for the contemporaneous conveyance of specie, or to accommodate the future settlement and netting of debts. In England, tally sticks were regularly used. From Paolo Zannoni, an excerpt from his book, Money and Promises, via Richard Vague and his invaluable Delancey Place…
A tally is usually a stick, or a bone, or a piece of ivory — some kind of artefact — that is used to record information. Palaeolithic tallies include the Lembombo bone, found in the Lembombo Mountains in southern Africa, reported to date from around 44,000 BC; the Ishango bone, which consists of the fibula of a baboon, from the Democratic Republic of the Congo (the former Belgian Congo), thought to be 20,000 years old; and the so-called Wolf bone, discovered in Czechoslovakia during excavations at Vestonice, Moravia, in the 1930s, and estimated to be around 30,000 years old. Marked with notches and symbols, these tallies are ancient recording devices, means of data storage and communication. Not merely artefacts, they are important historical documents.
In England, from around the twelfth century, and for over 600 years, tallies became important financial instruments, a key part of public finance and an answer to a perennial problem for money-lenders, merchants and those involved in commerce and trade: how to both facilitate and record the exchange of goods, services and commodities. Reading these English tallies, understanding their history and their changing use, provides us with an understanding not only of the nature of individual financial transactions during the late medieval and early modern period, but also of the development of banking practices in England and its relationship to the English state.
Usually made of willow or hazelwood, tallies were used to record the key information of a financial exchange. The name of the parties involved, the specific trade and the date were written on each side of a stick. Notches of different sizes — which stood for pounds, shillings, and pence — were also cut on both sides. Then the stick was split in two along its length, creating a unique jagged edge; only those two pieces could ever fit perfectly together again. When someone presented one side as proof of a transaction, the parties could check for the right fit.
The potential uses for such a simple tool are obvious.
To begin with: an example of the early use of tallies as a record of debt repayment. John D’Abernon was the Sheriff of Surrey. His portrait in brass, in Stoke D’Abernon Church, Cobham, shows him as a knight in full armour, wielding a broadsword.
When he died, D’Abernon left his title, possessions and debts to his son, also named John. In 1293, we know that John D’Abernon gave two pounds and ten shillings to the Exchequer to pay a fine on behalf of his father. How do we know? Because at the time of payment, the official tally cutter made a series of notches on a stick: two cuts for the two pounds and one smaller notch for the ten shillings. The stick was then split, with the longer end going to John, and the shorter end staying with the Exchequer. The following words were inscribed on both sides: ‘From John D’Abernon for his father’s fine’ and ‘XXI year of the King Edward’.
John could thus prove to anyone that he had paid the fine of his father — simple and convenient.
Tallies also enabled the functioning of the tax system in medieval England, which was a rather more complex affair. The process took months to complete. It worked roughly like this. Tax receivers collected
revenues from the King’s subjects at Easter. They then passed them on to the Exchequer, which completed an audit in late September or early October. At the time, the Exchequer had two branches: the Lower and the Higher. The Lower Exchequer received and disbursed the revenues. The Higher Exchequer audited the process. They used tallies to track who had paid whom. As soon as the Lower Exchequer received the revenues, the tally cutter recorded the payment on the tally and split the stick. The tax receiver — the debtor — got the longer part, called the ‘stock’. The Exchequer — the creditor — kept the short end of the stick, called the ‘foil’. And once a year, at Michaelmas, the Higher Exchequer audited the whole process by matching stocks and foils. The stock was the proof that the collector had not merely pocketed the tax revenues.Over time, both the use and appearance of the tallies began to change: in the early years, tallies were 3 to 5 inches long; later, they grew to be 1 to 2 feet long, and sometimes much longer. More money meant more notches; more notches, in turn, required longer sticks. One of the last issues of tallies made by the English Exchequer was in 1729, for £50,000: the tally is a whopping 8 feet, 5 inches long, visible proof of the growth of public spending, taxation and inflation.
As the appearance of the tallies changed, so too did their uses. Inside the Exchequer, they served as receipts for money paid by taxpayers. Outside the Exchequer, they began to be put to entirely different purposes.
The business of the Exchequer simply could not work without the tally sticks. They were essential for auditing and controlling public finances, which obviously made them excellent collateral for a loan.
The tally was not a mere generic promise to pay, but a strong, unique claim on the proceeds of the Exchequer’s revenue stream. It identified the cashflow and the individual in charge of paying; the creditor gave the stock to the indicated tax receiver to get coins from a specific revenue stream, and a lender was sure to get his coins sooner or later. The humble English tally stick was therefore ripe to become a veritable public debt security, not merely a receipt. They functioned just like paper public debt securities, except instead of being written on paper, the transactions were instantiated and inscribed on sticks.
To take an early example: Richard de la Pole was a merchant who traded wool, wine and corn with France and central Europe in the early 1300s. He had a reputation for using debts aggressively to grow his business, which appealed to King Edward III and his advisors, who thought they might be able to make use of his skills. So, they appointed him Royal Butler. The job of butler was to supply all sorts of goods — food, wine and arms — to the royal household and to the army. We know that in 1328 Richard bought some wine from the French. As a good businessman, as Royal Butler, did he pay for the wine in coins? He did not. Rather, in order to pay the bill, the Lower Exchequer cut eight tallies, which were addressed to the collectors of taxes for West Riding in Yorkshire, listing the tax revenues earmarked to settle the debt. The Lower Exchequer gave the foils — one half of all the eight tallies — to Richard, who handed them to the merchants who sold him the wine. The merchants then exchanged the tallies with coins from the taxes paid in West Riding, and finally, a few months later, the Higher Exchequer called upon the tax receivers to account for the shortfall of cash, whereupon they presented the eight foils, which had been first given to Richard, as proof of the payments made.
To be clear: unlike coins, tallies did not actually settle debt. By accepting a foil, a vendor was effectively agreeing to a delayed payment from the Exchequer; the tally was a kind of guarantee that they would get coins. For the state, meanwhile, the tally was a convenient way to borrow from its suppliers, or a form of what we would now call vendor financing — the citizens and merchants who sold goods and services for tallies were effectively financing the state, in much the same way as those who lent actual coins to the Exchequer…
How record-keeping became finance: “Tally Sticks for Money,” via @delanceyplace.
Having looked back, we’d do well to heed Jack Weatherford‘s admonition (in his 1997 book The History of Money):
As money grows in importance, a new struggle is beginning for the control of it in the coming century. We are likely to see a prolonged era of competition during which many kinds of money will appear, proliferate, and disappear in rapidly crashing waves. In the quest to control the new money, many contenders are struggling to become the primary money institution of the new era…
* Adam Smith
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As we contemplate currency, we might recall that it was on this date in 1888 that William Seward Burroughs of St. Louis, Missouri, received patents on four adding machine applications (No. 388,116-388,119), the first U.S. patents for a “Calculating-Machine” that the inventor would continue to improve and successfully market– largely to businesses and financial institutions. The American Arithmometer Corporation of St. Louis, later renamed The Burroughs Corporation, became– with IBM, Sperry, NCR, Honeywell, and others– a major force in the development of computers. Burroughs also gifted the world his grandson, Beat icon William S. Burroughs.
“Follow the Money”*…
Chinese crime syndicates are operating underground banks to launder the proceeds of fentanyl sales. But, as Miles Kellerman explains, their practices, and the risks they pose, are far from new…
One way of thinking about finance is to imagine it as an endless web of information assembly lines. Every transaction starts as a signal: some person wants to buy some thing. This is the raw material of demand. That material must, in turn, eventually make its way to whomever is in a position to supply. Sometimes this is easy. When you buy mangos at a farmers market, for example, you have direct communication with the supplier, handing over cash with one hand while receiving mangos with the other. But such direct interaction is rare. For most transactions, buyer demand must first travel along informational conveyor belts, where intermediaries shape, mold, and redirect that raw material before it reaches suppliers.
Take residential real estate. If a couple wants to purchase a beachfront bungalow in Santa Barbara, they probably aren’t going to just show up at the front door with a duffle-bag full of cash. That would be weird. Rather, they are much more likely to express their demand through a realtor. This information then makes its way down the assembly line, where it passes through a series of intermediaries: the seller’s realtor, title company, mortgage advisor, attorney, and, finally, the bank.
But buyers and sellers are not the only ones interested in this process. There is also the inquisitive eye of the state. Every stage of the information assembly line contains clues — about unpaid taxes, money laundering, terrorist financing, and all sorts of other shenanigans. The state would love to patrol every assembly line looking for these clues, like a mustached inspector peering over the shoulder of nervous factory workers. But this is expensive. And many of us would prefer that our information is assembled by intermediaries in private.
The state’s solution to this problem has been to outsource surveillance. It requires that certain intermediaries on the information assembly line look for signs of suspicion and report those suspicions to regulators. These are what is referred to as Anti-Money Laundering, or AML, obligations. At the risk of abusing the analogy, intermediaries with AML obligations are like factory produce inspectors. They spend all day staring at fruit as it travels across the conveyor belt, sorting out the rotten apples and tossing them into separate bins.
But what if, somewhere along the production line, the informational conveyor belt just…disappears? The Financial Times has reported that Chinese crime syndicates are capable of performing such sorcery. These syndicates, the FT writes, are using a “new” network to launder the proceeds of fentanyl sales, one that “…minimizes the movement of funds across borders.” The money simply disappears in one place and reappears in another, as if governed by quantum physics. But this is not magic. Nor is it new. It is instead an alternative conveyor belt of information, one that has operated outside the confines of the state for over a thousand years. And it goes by a simple yet ominous name: underground banking.
Imagine, for a moment, that you are a textile merchant somewhere along the 6,000 kilometer stretch of the ancient Silk Road. Every business has risks. But your risks are a bit more extreme. Large stretches of your trade routes are located in harsh desert climates where water is sparse. Nor is there any guarantee of security. Nomadic raiders could strike your caravans at any moment. And, even if you survive the trip, you could arrive to your destination only to find that it has been sacked by Attila the Hun (or, later, the roaming armies of Genghis Khan).
The last thing you want to do, in such a dangerous environment, is carry cash on you. Credit cards would be a great alternative. “No!” you might explain to Chase customer service after having your card stolen by Hun raiders, “I definitely did not order horse archers.” But it’s about 600 – 1,900 years too early for that. In this pre-electricity era, you need an alternative system. Specifically, one that allows you to manage your payments, settle outstanding balances, and avoid the perils of carrying money across the Persian desert. Enter Hawala.
Hawala is an Arabic term roughly meaning “to change” or “to transfer.” It refers to a system in which networks of brokers (hawaladars) facilitate the movement of value from one geographic location to another. Nobody really knows when Hawala was first used. But there is evidence from the 6th century that Muhammed, the founder of Islam, was familiar with at least some version. Similar systems, with equally ancient roots, have existed in India (Hundi), Thailand (phoe kuan), and China, whose term Fei-Chien translates to flying money. And they have collectively come to be referred to as different varieties of “underground banking.”
Here’s how a Hawala transaction might have worked on the Silk Road. Say you are a merchant in Iran who wants to import Aleppo pepper from Syria. Rather than drag heavy coins across the desert, you provide the necessary money (in whatever form was used at the time) to your local broker. In return, the broker would issue what was, in effect, a bill of exchange — a written order to pay an equivalent amount of money to the supplier at a later date. Once you arrive to Aleppo, you present that document to a Syrian broker, who honors the bill of exchange by issuing the money to the supplier in local currency. Each broker charges a commission for their services and settles their balances through repeated business.
With this simple maneuver, currency has been exchanged across borders. But rather than physically moving money from one place to the next, the brokers have received and distributed local currency from their respective pots. The only true transfer is one of information…
… Trust is also essential to contemporary Hawala systems. But today’s networks are more focused on facilitating cross-border payments and currency conversions rather than international trade. Remittances are one important example. If a worker in Belgium wants to send money to their family in Pakistan, they can do so through their local Hawala broker. But unlike their ancient predecessors, there is no need for these brokers to issue a bill of exchange. They can simply pick up the phone or text their foreign counterparts that the money has been deposited.
But how can the worker be sure that the person picking up the money is actually their family member? One common solution: secret codes. Hawala brokers will often require each party to express these pre-agreed codes, which could be as simple as reciting the same verse from the Quran. Another option, observed in a Chinese context, is to present a sugar cube with a specially imprinted symbol — and swallow it once the transaction is complete.
You might be thinking that, aside from the secret sugar cubes, this all sounds pretty familiar. And you would be correct. Hawala is, in essence, the earliest known form of trade finance. It is also a predecessor to “modern” payment institutions and foreign exchange providers…
… Wise [an “above-ground payment system] implies that Hawala is informal because it is not regulated by the state. This is the same logic often applied to characterize such networks as “underground” banking systems. There is a historical irony here. Hawala, Hundi, and similar networks operated for hundreds of years before ‘states’ were a thing. And in some situations, such as the British Raj, sovereigns endorsed their use as indigenous forms of payment. Thus ‘formality’ is probably better thought of as a spectrum here, one which depends on both the state’s desire to regulate and the market’s desire to be regulated.
Nevertheless, Wise is correct that hawaladars are largely unregulated. In fact, they are outlawed in many countries, something Wise — a competing service — is keen to emphasize. And the reason is simple: Hawaladars often maintain fewer records of the transactions they facilitate for their clients. They disrupt, in other words, the informational assembly lines of the ‘formal’ financial system, undermining the capacity of the state or its intermediaries to perform surveillance. And this is music to the ears of a particular clientele. Namely: human traffickers, terrorists, and other actors with nefarious motives to move their money in the dark…
[Kellerman describes how Hawala works and gives examples from the Underground Silk Road…]
Here we see both the benefits and limitations of Hawala as a mechanism for financial crime. Like their ancient predecessors, Chinese brokers can move money from one place to another without a trace, sidestepping the informational assembly line of the state-controlled financial system. But additional steps are needed to actually launder the cash. And these steps often involve re-entering the assembly line by interacting with regulated intermediaries. The Chinese businesses buying Mexican products for the cartel, for instance, would have done so through banks with standard obligations to perform AML checks. Thus Hawala can obscure the movement of cash but cannot protect that cash once it enters the ‘formal’ economy.
And there is another caveat: a big one. Chinese underground banks move money through alternative conveyor belts of information which rely on the use of ‘encrypted’ WeChat texts. But are these really so secure? It is commonly understood that the Chinese state surveils WeChat and other messaging services. This has led some to speculate that certain Chinese government officials must be participating in these underground networks. Perhaps we will never know.
What we can say for certain is that the use of app-based communication is a deep security vulnerability for underground banking. These networks are attractive to drug cartels and other bad actors because they disrupt transactional audit trails. Phrased differently: they disassemble information. But communication can undermine these benefits by creating another type of paper trail, one that reassembles how cash moves from one pot to another. Criminals should take note. And so too should any public officials that may be assisting them. To paraphrase the great Lester Freeman, if you follow the cash, you’ll find the money brokers. But if you start to follow the texts, you don’t know where it might take you…
The advantages– and risks– to criminals of underground banking: “The (Dis)assembly of Information,” from @Miles_Kellerman. Eminently worth reading in full.
* “Deep Throat” in All the President’s Men (though it’s not clear that the real deep throat ever actually said that…)
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As we think about transnational transactions, we might recall that it was on this date in 1790 that an act of Congress, passed at the urging of Treasury Secretary Alexander Hamilton, created the United States Revenue Cutter Service– an armed maritime customs enforcement agency aimed at enforcing tariffs by reducing smuggling… which later became the U.S. Coast Guard.
“Before beginning, plan carefully”*…
The marvelous Matt Levine on one of the vexing challenges facing those who preserve themselves cryogenically…
See, if you go to a regular trusts and estates lawyer, she will ask you questions like “if your spouse and children die before you, whom do you want to inherit your estate,” but if you go to a science fiction trusts and estates lawyer, she will ask you questions like “if your frozen head cannot be attached to a fresh body and reanimated in 200 years, but your consciousness can be cloned in a computer simulation, would you like your estate to go to the cloned consciousness or stay with the frozen head?” Meanwhile I suppose if you go to a regular financial planner, he will ask you questions like “how much equity risk are you comfortable taking between now and retirement,” while if you go to a science fiction financial planner, he will ask you questions like “where are you most comfortable investing for the next 200 years, given that you will not be able to change your asset allocation decisions during that time, because you’ll be dead?”
When you are a kid, science fiction is fun because it imagines amazing futuristic technologies. And then you grow up and you realize that what’s really fun are the legal and financial technologies that are called into being by those physical technologies: Sure sure sure reviving a frozen head is great, but how does the frozen head get a credit card? Bloomberg’s Erin Schilling reports:
Estate attorneys are creating trusts aimed at extending wealth until people who get cryonically preserved can be revived, even if it’s hundreds of years later. These revival trusts are an emerging area of law built on a tower of assumptions. Still, they’re being taken seriously enough to attract true believers and merit discussion at industry conferences.
“The idea of cryopreservation has gone from crackpot to merely eccentric,” said Mark House, an estate lawyer who works with Scottsdale, Ariz.-based Alcor Life Extension Foundation, the world’s largest cryonics facility with 1,400 members and about 230 people already frozen. “Now that it’s eccentric, it’s kind of in vogue to be interested in it.”
He and others are trying to answer questions that at times seem more like prompts in a philosophy class.
Can money live indefinitely?
Are you dead if your body is cryonically preserved?
Are you considered revived if you have only your brain?
And if you’re revived, are you the same person?
So many good legal questions — “House considers the revived person to be different in the eyes of the law, in part because a person can’t be the beneficiary of their own trusts” — but also great financial ones.
Here’s one: Should you buy Bitcoin for your long sleep? The argument for Bitcoin is that you can hold it, indefinitely, without relying on anyone else: If you put 10 Bitcoin in a wallet and only you know the private key, and then you die and get frozen and come back in 200 years, no one will have taken your Bitcoin, legal rules about inheritance and perpetual trusts don’t matter, and you don’t need some succession plan for the trustees and financial advisers who will take care of your assets. You just have to make sure you remember your private key as you’re dying. Legal rules can change, human institutions can change, but your Bitcoin is immutable.
The argument against Bitcoin is, of course, what if people stop valuing Bitcoin? Putting your money in Bitcoin is a hedge against change in other human institutions, but it puts a lot of eggs in the basket of one human institution, “treating Bitcoin as money.” It’s a bit weird to bet that that’s more permanent than anything else.
More generally, what is money anyway? “It may be difficult to know what role money will play in a post-[artificial general intelligence] world,” says OpenAI to its investors, and what if OpenAI gets to artificial general intelligence before anyone gets around to unfreezing the heads? You might be leaving your future self all the wrong stuff…
Very long-term planning: “Cryogenics Law,” from @matt_levine via Ingrid Burrington’s wonderful newsletter, “Perfect Sentences” (in this instance, “Sure sure sure reviving a frozen head is great, but how does the frozen head get a credit card?).
* Marcus Tullius Cicero
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As we chill, we might recall that it was on this date in 1983 that the coldest (natural) temperature ever recorded on Earth was registered by the research station at Vostok, Antarctica: -128.5 degrees Fahrenheit (-89.2 degrees Celsius).
We might also note that today– July 20, 2024– is the date on which the action in Octavia Butler’s Parable of the Sower begins: “…in 2024, when society in the United States has grown unstable due to climate change, growing wealth inequality, and corporate greed…”
“Cash is king”*…
“The king is dead, long live the king” Nick Routley on the replacement of cash by digital payment…
As credit cards and digital wallets (e.g. Apple Pay, Paytm, Alipay) see increasing adoption around the world, the share of cash being used in transactions is plummeting.
The chart above looks at cash as a share of transaction value in selected countries at three time periods (2019, 2023, and 2027P). Highlighted in red is cash’s projected drop from 2019 to 2027. This data showing the death of cash comes from WorldPay’s Global Payments Report 2024.
The prominence of cash for use in transactions is dropping in every country measured. This includes countries where cash was preferential method of payment in POS transactions.
One clear example is Nigeria. In 2019, over 90% of transaction value was still in cash payments. That number has now fallen to 55% today. Cash is still the leading payment method in Nigeria and a handful of other nations, but current trends indicate this may not be the case for much longer. For now, cash also remains the leading method of payment in various South American and East Asian countries…
All that is solid melts into air: “Charted: The Death of Cash Transactions Around the World,” from @NickRoutley in @VisualCap.
For more: “What is a cashless society, and what does it mean for businesses?“
And for a consideration of the pros and cons: “Should We Become a Cashless Society?“
Also apposite: “Target said that due to ‘extremely low volumes,’ it would no longer take personal checks.”
* Modern saying, summarizing the position in a recession
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As we click, we might recall that it was on this date in 2001 THAT The Code Red worm was released onto the Internet. Targeting Microsoft’s IIS web server, Code Red had a significant effect on the Internet via the speed and efficiency of its spread. Much of this was due to the fact that IIS was often enabled by default on many installations of Windows NT and Windows 2000. But Code Red also affected many other systems with web servers, mostly by way of side-effect, exacerbating the overall impact of the worm.
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