There is no reason (except a mistaken physical determinism) why mental states and physical states should not interact ... If we act through being influenced by the grasp of an abstract relationship, we initiate physical causal chains which have no sufficient physical causal antecedents. We are then “first movers,” or creators of a physical causal chain. (Karl Popper, 1953)
It from bit symbolises the idea that every item of the physical world has at bottom — at a very deep bottom, in most instances — an immaterial source and explanation; that what we call reality arises in the last analysis from the posing of yes-no questions and the registering of equipment-evoked responses; in short, that all things physical are information-theoretic in origin and this is a participatory universe. (John Wheeler, 1989)
What I could not properly resolve was the nature of the relationship between the mode of thinking and the actual state of affairs. That problem continued to preoccupy me. (George Soros, 2009)
Cryptocurrencies, or simply cryptos, are all the rage these days. Bitcoin’s rise to fame has become exponential and its price is approaching $20,000, after starting the year around $1000. Bankers, including central ones, have expressed skepticism about its value, noting that “nothing is backing it up”. From the sound of it, their skepticism is perhaps understandable: another crypto, Ether1, echoes aether, the invisible substance that permeates the universe according to medieval science.
Nobel laureate Robert Shiller also commented on the rise of cryptos. He repeated his thesis of the similarly ethereal animal spirits and narratives, stating that “markets are driven by stories” without necessarily a link to fundamentals. Finally, in the broader scheme of things, the Bank for International Settlements (BIS) published a timely survey on “Asset prices and macroeconomic outcomes,” highlighting the difficulty in understanding macrofinancial linkages. What has all this in common? It points to the broader mind-matter issues that play a complex, and often confusing, role in our increasingly intangible and virtual economy.
So, with cryptos as symptoms, I will address the important metaphysics that we struggle with as investors, both in our theories and practices. Along the way, I want to make clear why physics-envy, as suffered by economic science2, is misguided.
The question implicitly asked by crypto-critics, namely “Is there anything of substance?”, is the mirror image of the question traditionally asked by philosophers: “Is there anything beyond substance?” The latter is raised in the broader metaphysical debate in cognitive science3 surrounding the so-called problem of consciousness, in particular regarding mental causality. On that note, Shiller implies with his thesis that Popper is right: mental constructs, like stories, impact markets and, by extension, the economy. In the extreme, can “faith-based” bitcoin indeed damage the real economy? Beyond stories and faith, the BIS ultimately wonders what type of causality is involved between asset prices and macroeconomic fundamentals. The key question in that regard is whether prices (reflecting mental states) can influence macroeconomic fundamentals (consisting of physical constructs, like factories, and physical output, like products).
Most practitioners will answer this question positively (for example based on their own tail-wagging-the-dog experience of the Global Financial Crisis or their sympathy with Soros’ concept of reflexivity). In contrast, based on their mechanical worldview, most academics and policymakers have a flawed and dangerously outdated understanding of market mentality, as I will discuss shortly. In any case, interpreting the wider causality implications, including those concerning knowledge, behavior, etc. is not that simple. Overall this dynamic plays out in what cognitive science calls ‘psychophysical space’. Among others, it is important to recognize differences in mental states. Specifically, the strength in the relationship between a mental state and a proposition of the world (W) varies. A belief about W, for example, is weaker than knowledge about W. On that note, our knowledge expands via discovery which, generally, can transform one mental state into another and subsequently impact the broader state it is part of. The role of randomness and luck should not be underestimated in that regard.4 This and related issues, for example regarding what happens to belief and knowledge when something is fake, are part of the subject matter called epistemic luck.5
Broader debates on mind-matter issues have been raging for centuries in cognitive science. Dualism, idealism, materialism, physicalism, and numerous alternative views6 are involved in these debates. One outcome is that mentality, including its causality, is considered complex (e.g. non-linear), while the laws of physics do not exhaust the fundamental laws of nature. It means, for example, that physicalism is not uniformly accepted as true. In contrast to cognitive science, economic science, unfortunately, ignores the relevance of these debates. Driven by physics-envy, it instead dogmatically subscribes to its own variation of physicalism. It basically assumes that an economic system is a machine, all economic effects can be engineered (away) and economic reality can be understood by translating the laws of physics into mathematical models.
Of course, naively one could say that ultimately any mental construct involves the brain and the latter is, therefore, the physical necessity to produce it. But apart from necessary is this lump of organic substance also sufficient to explain mentality in all its forms? By extension, is physicalism, and thereby physics, sufficient to explain economic dynamics? There are strong arguments to doubt this due to the complexity of the economic system. For starters, I will focus on supervenience and emergence to deflate economic physicalism.
Supervenience is a hierarchical concept that helps to understand the relationship between types or classes of properties. In particular, it describes the case where higher-level properties are determined by lower-level properties. According to one interpretation, a set of facts (A) supervenes on another set of facts (B), if B determines whether A is true or not. In other words, A-facts offer nothing over and above B-facts in determining the truth. A more relevant interpretation is a variation of the no-arbitrage rule in finance: the (mental) value of a security supervenes on the schedule of (physical) future discounted cash flows.7 Once the distribution of those cash flows is determined, the value of the security becomes metaphysically settled. Any security which has its cash flows distributed in exactly the same way is equally valued.
In general, most properties supervene on physical properties8. But, famously, the value of fiat money does not supervene on the coins and paper it is made up off. So, there is something over and above the physical features of money that determines its value. Also, supervenience does not equate to dependence nor reduction.9 Why should we question that economic science can be reduced to physics (as mainstream thinking tends to believe)? Because of the problem of how the physical (real) economic world is accompanied by the qualitative experience (e.g. market mood) of the participants in that world. For theories on capital markets, it leads to an explanatory gap between physical market activity and the experience of that activity in a qualitative way by human participants. The difficulty lies in the entanglement of these physical and mental states into the full market state. Separation of the former two is impossible but, even if it were, the latter would be abolished. I’ve called this the market’s mind-body problem. This problem is highly resistant to physical explanations and thus exposes the limitations of physics and, by extension, physicalism.
Emergence is another hierarchical but more dynamic concept. It describes the phenomenon when higher-level (or emergent) properties arise out of the interaction of lower-level properties. Although there are multiple interpretations10, in our case emergence also means that these higher-level properties are not exhibited individually by the lower-level properties, i.e. they are novel and unique to the collective. In particular, the state/behavior of the market as a collective does not follow from the state/behavior of its components in isolation, nor in different constellations. Market moods and sentiment, like exuberance and despair, are examples of higher-level market properties that emerge due to the interaction of the bodies and minds of market participants (supported by tools, like computers). Specifically, they are mental states that are shared collectively by market participants and are exhibited by the market’s mind as phenomenal overlays.
Crucially, these and other emergent properties of the market can reflexively exert so-called “downward causation” by constraining their constituent parts (i.e. market participants) to only a few of the possible behaviors they would exhibit were they to act independently of each other. To look for the medium in this process we can start by asking what happens if the object of awareness (i.e. that which occupies the brain, aka attention) is simultaneously experienced by multiple minds? In other words, it cannot be isolated to study in physics terms. More importantly, what if that object is non-material, like a bit, that not only provides concentrated information of the state of the world but also facilitates Wheeler’s “participatory universe” in terms of allowing observers to create reality?
The Market Mind Hypothesis (MMH) argues that there is something peculiar in that regard about prices. First, prices are numerical symbols, in terms expressed by a physicist, Wolfgang Pauli (1948) describes:
...images with strong emotional content, not thought out but beheld, as it were, while being painted. Inasmuch as these images are an “expression of a dimly suspected but still unknown state of affairs”, they can also be termed symbolic.
Under normal circumstances, prices come into being via the most elusive of all mental events: discovery. What makes the discovery in general so elusive is that (i) it is derived from the unknown and (ii) it is unpredictable. In short, a discovery is a surprise with luck playing a big role. Process-wise, a discovery originates with an individual’s insight, often after reflection involving both logic (i.e. System 2) and intuition (System 1). Importantly, as a mental state, an insight not only consists of new knowledge but is also colored by the famous A-ha sensation (“System 3”). It conveys novelty in a qualitative sense that, I believe, has an evolutionary purpose in that it incentivizes us to seek further. Yes, while the sensation is often pleasant, sometimes it comes as a shock.11 But always and everywhere, a discovery fills a gap in our understanding and, in that sense, makes us more complete.
In addition, the subsequent valuation of a discovery is done collectively. In science, a new theorem, for example, proceeds via peer review and independent tests. In markets, a technological innovation, for example, proceeds via the valuation of its utility by consumers, respectively investors. In fact, we often see a reflexive chain of discoveries from the real to the financial economies. Starting with a novel product discovered, say, by an inventor, it is subsequently discovered by consumers, while the prices assessing its monetary value are discovered by investors. In turn, market prices invite further discoveries in the real economy. Following on from this, price discovery takes place between at least two human minds, the buyer and the seller (even if machines are increasingly involved). In other words, prices emerge from human economic exchanges unbounded by individual brains. This collective aspect, combined with the element of surprise, makes prices peculiar in terms of mental efficacy. In technical terms, intersubjectivity and novelty are important emerging properties of prices that exceed explanation from purely an individual brain and ultimately make the market’s mind a complex adaptive system.
What can we infer from this in terms of our earlier reflections? To take my cue from Popper and Shiller: price is Popper’s primary “abstract relationship” in markets, namely the ratio of monetary units per participation in Shiller’s story. Not only are prices not reducible to individual brain activity in the physical sense, but their discovery also involves the full mental spectrum of interacting conscious and unconscious minds, varying from distributing cognition to intersubjectivity. It means, for example, that the radical uncertainty faced by investors not only consists of the unknown external events but also the unknown internal ones. It is furthermore complemented by the market mood that emerges as a qualitative overlay with downward causation: it constraints, e.g. via inputs into models, the behavior of the individual participants. Overall, it means that causality within the economic system remains ambiguous.
A few more words on the rise of cryptos and the distributed ledgers that support them. Obviously, they are going through the process of discovery as just described.12 But it is too early to determine, for example, whether their rise will spawn higher-level properties that will have a truly novel top-down influence on the economic system. We are also back to square one: the difficulty of determining their metaphysical nature, including that as perceived by (potential) users. Beyond its digital essence as software (i.e. bits), is bitcoin treated as a currency or a commodity? Again, this is relevant as higher-level properties supervene on this. As far as the critics are concerned, central bankers should be careful to throw stones from their glass towers. Fiat money is not exactly of the substance itself (“thin air” comes to mind). What cryptos and fiats have in common is exactly their non-material nature and dependence on the mental state of trust. Specifically, although superficially cryptos and fiats seem to differ regarding their trust in decentralization, both supervene on trust in other human beings. The embryonic willingness to trust machines has major implications for human exchanges in that regard.
Allow me to explain. Success in Keynes’ beauty contest (i.e. the market), namely to correctly anticipate degrees of average opinion, ultimately relies on Theory of Mind (ToM). ToM is a cognitive science concept that describes our ability to “theorize” about the mind, including those of others, and to attribute states to it. We use it all the time in our interactions. In the case of markets, participants need to recognize trust because any exchange (be it via barter, credit, or money) can only take place if that state is shared between buyer and seller. Unfortunately, especially in speculation, we are prone to overconfidence. The first risk lies in overstepping our own capability. In other words, we push ToM to the limit in that we believe we can actually “mind read,” culminating in anticipating the overall market, for example, based on extrapolation. The particular case of a “greater fool” bubble, which is exclusively based on trusting the buyer to pay more, relies disproportionately on ToM. Importantly, both fiats and cryptos are vulnerable under conditions where ToM is (judged to be) no longer reliable. The most extreme situation where this occurs is when there are no human minds involved and trading has become dehumanized when automatons make discovery meaningless. In such a world I believe we will have succumbed to the second risk: automation bias. So, machines allow us to extend our minds, but we have to get the balance right. Whether bitcoin is a “greater fool” bubble is almost trivial in this context.
No doubt some readers will judge this article as too esoteric, e.g. “I can’t make money with this.” But topics like artificial intelligence, cryptos, quantum computing, and virtual reality raise difficult questions that should concern investors. They include those of the ontological kind (e.g. “What is real?”), but also epistemological questions (“How do we know?”) and ethical ones (e.g. “Can we outsource this decision to a computer?”). Moreover, both finance and money have been equated to alchemy. Central bank policies like forward guidance and the wealth effect implicitly embed mental causality. Epistemic luck is relevant in these times where real and fake are hard to distinguish and brains are again confused with a bull market. The list goes on and on and nowhere have these topics been addressed as thoroughly as in cognitive science. Thus my translations in the context of MMH of which this article is an example.
Finally, what is crucial is to remember Lehman’s Lesson. Its collapse was a reality check, telling us that the economy is not a machine, nor is the market. The problem is that we continue to treat them as such, arguably increasingly so. This flawed ontological commitment is very expensive and leads to many unintended but obvious consequences we’re confronted with now, varying from low productivity growth to inequality. It is this that puts up the sign of Dante’s Inferno, not bitcoin. Being aware of the mind-matter issues at play, on the other hand, is the first ray of hope for rebalancing the economic system.
References
Pritchard, D. 2005. Epistemic Luck. Oxford University Press.
Seager, W. 2014. “Why Physicalism?”. Mind and Matter, Volume 12, Issue 2.
Footnotes
1 Formally, Ether is the currency value of Ethereum, a distributed ledger technology.
2 I use the term economic science to refer to both economics and finance as nested disciplines.
3 I use the term cognitive science to refer to mind disciplines that include philosophy, neuroscience, and psychology.
4 This is the focus of a project I currently work on with collaborators.
5 A thorough analysis is provided by Duncan Pritchard (2005) at the University of Edinburgh. It also relates to Soros’ fallibility and Taleb’s Fooled by Randomness.
6 Examples include monism and panpsychism.
7 Whether the statement is correct does not matter in this case. We are only interested in what it says.
8 A subtle distinction can be made in that regard between physical properties and material properties. The latter is arguably more fundamental, in terms of nature, making the former “higher-level”. The same goes for quantum properties.
9 A further distinction is between ontological dependence and epistemological dependence. For more details, see Seager (2014).
10 Including strong, weak, and contextual emergence.
11 In other words, the experience embodies an implicit value. This is another example of the similarity between minds and markets.
12 Even though there were earlier versions of electronic cash.
