INTEGRAL ECONOMICS

Stable Instability

Daniel O'Connor | Integral Ventures, LLC

Stable instability implies that recent economic trends areunsustainable due to a sustained impairment of necessarydegrees of

transparency

choice

, and

accountability

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Stable Instability

Daniel O'Connor | Integral Ventures, LLC

In the midst of what appears to many like asustainable bull market in stocks, housing, andbonds, there are just a few market observersexpressing concerns about what appears to be agrowing instability beneath the surface. One of them is Stephen Roach of Morgan Stanley who, inhis latest commentary,

points to the forebodingsimilarities between the market conditions of 2005and those of 2000, both the

objective indicators of excess

and the

subjective indicators of denial

:On this fifth anniversary of NASDAQ 5000,there is an eerie sense of déjà vu. Unlikethe excesses in equities five years ago,today’s bubble is more of an interest-rateand currency phenomenon—complete withextraordinary compressions of interest-ratespreads in notoriously risky asset classessuch as emerging-market debt, high-yieldsecurities, and a broad array of creditinstruments. In my view, these bubbles are joined at the hip, with today’s excessesvery much an outgrowth of the post-equity-bubble defense tactics of America’s FederalReserve. Excess liquidity and extra-ordinarily low real interest rates are indeedthe “candy” of the current profusion of carry trades.There’s another important similarity withthe heady days of early 2000—one thatpertains more to the psyche of themarkets. Emboldened by a recent outbreakof Goldilocks-type conditions in the macrospace—namely, new hopes of inflationlessgrowth—investors are becoming more andmore combative at my rebalancingpresentations. “You don’t get it,” theyincreasingly lecture me, “we live in a newlysymbiotic world.” After all, they go on tosay, as long as Asian central banks andtheir infinitely potent printing presses keepfinancing the excesses of the Americanconsumer, why worry? "It’s in everyone’sbest interest that this continues,” is thepunch line I hear all too often these days.And, of course, that’s pretty much the wayit has worked out so far, with the majornations of the world having managed tocope just fine with all the stresses andstrains I seem so concerned about. I amgetting challenged more and more thesedays as to why I believe imbalances willever come to a head. Motive is not myconcern. I certainly concede that it is ineveryone’s best interests to put off the dayof reckoning. The big question is, Can they?With that overview, Roach then suggests that thisapparent stability in markets may be masking agrowing instability in the global economy, one thatwill eventually manifest in a dramatic rebalancing of markets:The answer lies in what can be called the “paradox of stability”—the possibility that aseemingly tranquil status quo is, in fact,masking a dangerous build-up of tensions.That is a clear risk today, in my view. Whileit is possible and, for some, even easy todraw comfort from the appearance of anew symbiosis between debtor (America)and creditor nations (mainly in Asia), thereis a worrisome undercurrent of tensionsnow building. Such signs are evident on thereal side of the global economy, itsfinancial underpinnings, and also in thepolitical arena. Ironically, this confluence of forces could well be reaching a critical mass just when investors have mistakenlyconcluded that this new symbiosis—codewords for yet another New Paradigm—isrewriting time-honored macro rules.This paradoxical arrangement of what I call

stableinstability

is a normal pattern in economic cyclesthat can be understood by reference to the MarketLearning theory I presented in the introductorychapter of a book I was writing a few years ago.

Market Learning

Market learning is grounded in the novel insightthat the rules governing

market

exchange

areessentially identical to the rules governing

social

learning

. In other words, the social learning practicethat we must use to gain a shared understandingabout the state of the world is actually very similarto the practice of market exchange we already useto buy, sell, work, earn, borrow, spend, and invest.Thus, by using each discipline to illuminate andextend the other, we may increase ourunderstanding of both and, most importantly,develop a practical theory of real markets that canhelp us resolve our biggest economic dilemmas.Both market theory and social theory, at least in

This paradoxical arrangement of what I call

stable instability

is anormal pattern in economic cyclesthat can be understood byreference to Market Learning.

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the practical versions I am working with, areempirically grounded yet ethically compellingtheories of how people make effective decisions inreal world situations. Understanding one can helpus understand the other. And with two methods of decision making based on the same generalprinciples, one focused on market exchange and theother on social learning, I have offered the contoursof a viable new exemplar:

market learning based onthe mutual pursuit of transparency, choice, and accountability

.I can begin to clarify these contours by reframing

market exchange

as a specific type of

action

designed to achieve certain results in the market,from starting a company to finding a job toinvesting for retirement. In doing so, I highlight theessential role of

learning

in the proper functioningof the market. As the figure below illustrates, the

actions

in this particular model are all

exchanges

of property rights between two people based on thesimple rule of

quid pro quo

—trading

this for that

onthe basis of a mutual agreement.The

values

refer to the specific value systems weuse to frame our market situations, determine ourdesired market results, design our exchangestrategies, and learn from our market experiences.They would certainly have to include the

preferences

expectations

heuristics

, and

biases

that economists have so carefully studied over theyears. But as we shall see, there is no good reasonwhy they should not also include the

deeper

structures

cognitive

moral

and

affective

development

that economists have so carefullyignored over the years. Nevertheless, for the sakeof simplicity, I will generally refer to them as

values

value functions

, a concept which elevates theneoclassical

utility

function

to a more humanisticlevel.Finally, the

results

include both the

intended

andthe

unintended

consequences

of our marketexchanges, each of which can generate

positivefeedback

for more of the same or

negative feedback

indicating the need for a change. Both positive andnegative feedback are incorporated into the

single-loop market learning

that either confirms ordisconfirms the previous exchange strategy, as wellas the

double-loop market learning

that eitherconfirms or disconfirms the value function fromwhich the exchange strategy was derived. Thus, itis the same general model of

social

action andlearning based on the work of Chris Argyris andJürgen Habermas, but adapted to produce a generalmodel of

market

action and learning.Taking this a step further, we can create yetanother model of market learning by reconstructingthe orthodox market exchange model of supply anddemand illustrated in the figure below. This requiresthat we recognize the market process implicit in thestatic image of market equilibrium as a process of market learning.In this view, the development within the market of supply and demand curves can be thought of as thecollective result of single-loop market learning byindividual market participants. The buyers andsellers who participate in the market on the basis of their own personal value functions would bid andask various prices for various quantities of goods,the most valid of which would result in theconsummation of actual exchanges. Over time,through their own individual yet interdependentprocesses of single-loop market learning, theywould acknowledge the results of past exchanges,