A Keynesian Theory of Mind

The Mental Cell of Autism

Autism is one the crueller tricks that nature plays on human beings, leaving sufferers isolated, incapable of making social connections and effectively trapped within their own heads. Although the causes aren’t fully understood some of the consequences are, and chief among these is the inability of sufferers to take on the perspective of others. This failure to develop a so-called theory of mind means they simply can’t understand the needs and motivations of other people.

According to John Maynard Keynes a proper theory of mind is just what an investor needs to keep one step ahead of the crowd, although others feel that Keynes’ approach to investing is tantamount to chasing returns all the way to poverty. It raises the question, though, as to how much a person’s genetic makeup determines the type of investor they are. Are effective value investors really just socially inept wallflowers or simply extremely focused individuals?

A Theory of Mind

It’s become clear that autism isn’t a straightforward condition. Although extreme autism is utterly disabling and sufferers can’t live a normal life or even look after themselves there is a spectrum along which we’re all spread out. Improved diagnosis methods have shown that many people have mild forms of the problem, usually referenced as Asperger’s syndrome. Such people prefer to be solitary and are generally fairly rubbish socially.

To explain this the concept of “theory of mind” has been developed by Simon Baron-Cohen who describes it as:

“… being able to infer the full range of mental states (beliefs, desires, intentions, imaginations, emotions, etc) that cause action. In brief, having a theory of mind is to be able to reflect on the contents of one’s own and other’s minds”.

In short, it’s the ability to mind read, which the majority of us can do effortlessly without even realising we’re doing it. We're able to take on the place of another person, to imagine what they’re thinking and then to respond on that basis. It’s the foundation of social interaction and when a person can’t do this, when they’re autistic, they’re locked in their own skull, unable to get out. A simple diagnostic test is to yawn: many readers will yawn in sympathy with the word let alone the action. Around half of us will yawn when someone else does, someone with autism won’t, ever.

Generally speaking people who suffer from autism are pretty much at the mercy of the world, but further along the spectrum Asperger’s syndrome allows for a wide range of behaviour. Usually it’s associated with poor non-verbal communication, a lack of empathy with other people and bad coordination. Of course, those symptoms apply to most men when drunk, but Aspbergers is a broad church and the range of effect is very wide. Most notably, though, they have problems with social interaction: in short, they have a poor theory of mind.

A Keynesian Theory of Mind

All of which is very interesting but what, you may be wondering, does it have to do with investing? Well, potentially rather more than you might think. Back in the 1930’s the economist John Maynard Keynes, in The General Theory of Employment, Interest and Money described an investing approach using the idea of a newspaper beauty contest to get his ideas across:

“.. professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one's judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be.”

And if that isn’t a use of theory of mind I’m an orang-utan. Ook.

Value Investing Can’t Work

Keynes’ point was that a successful investor needed to anticipate what other investors were going to be interested in. He went further, however, and produced a powerful argument against value investing – on the grounds that while it might be theoretically a nice idea in practice it wasn’t practicable. Investment based on fundamentals was, in Keynes’ view, impossible because individual human psychology simply didn’t permit it to succeed. In his view ‘enterprise’ – his term for rational investment on a long term basis:

"...only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die;—though fears of loss may have a basis no more reasonable than hopes of profit had before".

Or, in other words, even value investors rely on a fine judgement about what people will want in the future, rather than a rational analysis of long-term income. A Keynesian theory of mind for investors implies that they need to spend more time thinking about what others will want than the underlying economics of any given investment.

From Keynes to Graham

Yet we know, to a reasonable degree of certainty, that there are investors who are able to make a very decent, long-term turn on the markets by dint of ‘enterprise’ alone: the so-called Superinvestors of Graham and Doddsville. So was Keynes simply wrong?

Well, likely not. Keynes put his finger squarely on the motivation of most investors who, for our sins, are created with a full theory of mind and are unwilling and unable to ignore their beliefs about what other people will want when they invest. Mostly they’re wrong, but turning off the switch that makes us human is an incredibly hard thing to do.

Yet there are people who can succeed in this. Warren Buffett has suggested that the most important attribute for an investor is “focus” which is possibly simply another way of saying that it’s important to ignore what other people think and to follow your own beliefs. Of course, your own beliefs need to be informed by analysis and infused with intelligence, but quite how you can both do that and function normally in polite society is beyond me.

A New Theory of Mind

One obvious answer – that the great value investors are, in fact, suffering from a mild form of Asperger’s – is certainly possible. Yet many of these people are amongst the best communicators of investment ideas and philosophies there are. However, what they tell us is that our innate theory of mind leads us astray in investment matters and to succeed we need to stop believing we can anticipate what other people will do: a position Keynes regarded as impossible.

Since “believing we can anticipate what other people will do” is practically a definition of the human condition this is easier said than done. Buffett himself has remarked that people who “get” value investing do so almost immediately and those that don’t never do. So perhaps being a good value investor isn’t something you can learn, because perhaps most of us can’t switch off our theory of mind at will. It would be an irony, really, if most of us can’t be good investors because most of us can’t help but think like humans. Still, far better that than the terrible alternative.


Related articles: Laplace's Hammer: The End of Economics, Ambiguity Aversion: Investing Under Conditions of Uncertainty, Metaphors of Mind and Money