Date: Sun, Nov 20, 2011 at 12:26 PM
Subject: On Kahneman part II, why no Inflation and an Ayurvedic Home Remedy!
With the objective of providing a respite from the travails of trying to make sense of the markets in the current environment, I have summarised below another article on the Nobel Laureate Daniel Kahneman, written by Michael Lewis. Lewis's interest in Kahneman was piqued after he had written the book "Moneyball" which detailed how professional baseball talent scouts keep making colossal mistakes in their evaluation of talent. What he was subsequently alerted to was that he had stumbled on a central finding in the area of cognitive psychology – that people typically make decisions based on relevant examples which are easily remembered ("availability heuristic"). Have also provided a link to a simple 5 question quiz prepared by Kahneman which illustrates some of the reasoning traps people continually fall into (I urge you to try it-it can be completed in less than 5 minutes!).
-The idea which won Kahneman the Nobel prize in economics (despite being a psychologist) was "Prospect Theory" , which he developed with his long time collaborator Amos Tversky. The theory detailed that when people are faced with a loss they become more risk-seeking and when they are faced with a gain they become more risk-averse.
-This theory provides the basis for phenomena ranging from why people are less likely to sell their stocks and homes in falling markets to why professional golfers become better putters when they are trying to save par (i.e. avoid losing a stroke) than when they are trying to make a birdie (i.e. gain a stroke).
-Their work also spawned the field of behavioural economics as they rejected one of the basic tenets of economic theory which goes back to Bernoulli's 18th century utility theory – that people are rational, selfish and do not change their tastes. Their approach being that people are not always rational and selfish and their tastes are constantly changing.
-A central idea of Kahneman in his new book "Thinking Fast and Slow" is that we have two different mental operations – System 1, which is fast-thinking based on intuition and is capable of misleading and being misled, and, System 2 which is slow-thinking and tries to prevent System 1 from making mistakes. System 1 is always switched-on while System 2 is lazy and is used only periodically.
-Kahneman and Tversy over the years have demonstrated through a variety of experiments the common thinking traps we all tend to fall into. For example:
-"Conjunction fallacy" – where the human mind gets wedded to stereotypes and vivid descriptions while making decisions, even when they contradict facts and defy logic.
-"Anchoring effect" – where judgement is heavily influenced by some random number or event and usually results in absurd decisions. This effect is widely prevalent in our decision making.
-"Representativeness heuristic" - when you do not account for the size of a sample. This can help understanding some forms of prejudice - if you haven't been exposed to a large number of people from a certain group, you're more likely to have incorrect assumptions about them.
-"Framing effect": being influenced by the way in which questions are worded rather than responding just to their substance.
-While their work may seem like a study of human stupidity - they had a rule that they would not study an example of human stupidity or irrationality unless they observed it in themselves – and describe it as "ironic research".
-Their work has influenced a vast variety of work – behavioural economics; reasons behind the poor performance of predictions by political experts; why investors underperform in their stock sell/buy decisions; Atul Gawande's book (Better, The Checklist Manifesto) which highlights the dangers of relying too much on intuition; and why switching traffic lanes is pointless.
Marvellous stuff – even if it is totally impractical to always rely on the System 2 type thinking – it will probably save us a lot of heart-ache (and money!) if we are at least aware that we are employing the System 1 type error-prone thinking. Kahneman's new book seems to be a must read!
On Why no Inflation:
Came across one of the clearest and simple explanations (from Bronte Capital) on why we are not seeing any inflation is the US (and the rest of the developed world):
"The explanation is simple enough. The Federal Reserve has too much credibility. Each time it increases the money supply it buys some asset (say a government bond or even a foreign security) and issues cash. And people hold the cash because it is a reasonable store of value. And it is a reasonable store of value because they trust - at the end of this cycle - that the Federal Reserve will eventually take its vault full of assets, sell the assets for hard cash (which it will destroy) and will thus suck the excess liquidity out of the system.
If people really believed the cash was trash they would all try to get rid of it (i.e. buy something) but collectively they could not get rid of it (every time they buy something it would have a new owner) and the result would be inflation. Inflation would then reduce the real value of the money stock to a level where people were comfortable holding it. To get inflation you need to damage the Federal Reserve's credibility. You need the Federal Reserve to make a credible promise to be reckless."
An Ayurvedic Home Remedy (Dr. Lad and Dr. Shashi Bala):
Heartburn and an acid stomach is a very common ailment , and rather than relying on the rather strong medications currently on the market, trying a simple Ayurvedic treatment might prove to be just as efficient:
-Take 2 tbsp of aloe vera gel with a pinch of baking soda. This should have an immediate soothing effect.
-Make a cup of lime juice (10 drops), organic sugar (1/2 tsp), baking soda (1/2 tsp) – add the baking soda at the end and drink it immediately to relieve an acid stomach.
-Drink 1cup of papaya juice with 1 tsp organic sugar and 2 pinches cardamom.
-Follow a pitta dosha-pacifying diet - i.e. no hot spicy food, pickles, fermented food, citrus fruits and avoid overeating.
-A cooling yogic breathing ("shitali pranayama"-sucking wind trough the tongue by rolling it into a tube shape) is very helpful. It cools as well as stimulates digestion.
-Avipatikar churan is an Ayurvedic herbal compound which, in my experience, and proved to be very effective in reducing acidity.
Happy System 2 type thinking!
Biharilal Deora, CFA, ACA
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