Marginal Thinking
Opportunities to exploit markets abound. Much of what exists reflects not the best thinking of the smartest investor but rather reflects an average of good ideas and some very bad ideas.
There is a class of language that is perfectly engineered not to explain but to keep at bay those who are not in on the joke or who are on the wrong side of the information asymmetry. For instance, you may have heard circa 2015 technology investors talk of a “long tail” investment strategy or “winner takes all” business model. This is not to explain anything but rather to communicate to an outsider that the speaker is smarter or at least better educated than you. Had more effort been put into the explanation perhaps Uber, Airbnb, and DoorDash would have been archetyped not as “zero marginal cost monopolies” but more clearly as “zero profit margin commodities”.
As Big Tech recedes from the headlines, Big Econ comes ashore in the form of inflation, a “cost of living crisis”, and “slowbalization”. If we are making up phrases I might propose “snowballization”. The political or social forces that drive the agenda of the day have a way of growing in strength and then eventually disintegrating, just as a snowball rolling down the mountain. Make up any portmanteau or maxim as you please, it won’t help to explain much.
If we live in a confused world full of households who do not understand the basic mechanics of how inflation is caused, and we do, the fact that so many public economists use obfuscating language to engineer superior social status and dodge cross examination rather than explain the basic mechanics in a logical manner has to carry some of the blame. Language is as much a shroud for misunderstanding and instrument of power as it is a basic and reliable tool of communication.
A candidate for the most unhelpful phrase in economics is “thinking at the margin”. One of the great insights of economics is that whatever has come before is not as important as what comes next. If you operate a strawberry greenhouse, you should not only think about the average price of strawberries and your average historical cost of production. On any given day you would think about the current market price, which could be $5.00 per pound, and what it would cost to produce more, which could be pennies for some seeds, soil, and water. Considering at a particular moment the additional cost versus the additional revenue of any productive effort is what it means to think at the margin.
Behind the not entirely harmless pretentiousness and obscurantism of using such language in daylight, “thinking at the margin” is a theoretically unimpeachable concept replete with intellectual land mines that have confused the curious beaver as well as droves and troves of serious analysts, and professional allocators of financial and economic resources.
Market prices that govern economic behavior no doubt become distorted for many reasons. Entrenched incumbent interests always have a dog in the fight. Who can blame the coal company for infiltrating renewable energy permitting meetings with studies claiming wind farms make cows depressed. That one group with something to lose may conspire to manipulate prices to discourage the other team in any zero-sum game is as reliable as water flowing down a mountain.
But such conspiracies are not the only way that progress is curtailed if not stymied. A conspiracy is not even necessary. To the extent that the humans responsible for informing and making the GDP-level investment decisions that determine the configuration of markets and the design of the industrial economy do not generate conclusions or, say, maps that reflect the territory, is another equally powerful driver of resource misallocation.
The phrase “at the margin” is issued by one theoretical economist to one practical investor to imply that the market price of anything, strawberries, bread or the S&P 500, is determined by the perfect harmonization of those who are buying and those who are selling.
In other words, the price of strawberries or equities could not be too low (or too high) because if it were too low (or too high) those who could have benefitted from exploiting the price difference would have already made enough purchases to increase (or decrease) to its “true” price. Thinking at the margin implies that the market price is determined by who has the highest willingness to pay. In more words, thinking largely in terms of the margin runs the risk of defaulting into the view that, whatever the price is, it is the accurate price.
We can illustrate the folly of “thinking at the margin” by drawing up a cartoon version of the classic conversation about market efficiency between the economist and the investor. Let us call the economist Smart and the investor Rich.
RICH: The United States, as with any empire throughout history, with the dollar as the de facto global reserve currency has the ability to print money and incur more debt without suffering all the typical inflationary costs because many foreigners also hold that currency.
SMART: Your reserve currency claim is overrated. Consider Japan which also effectively equally high levels of debt but does not have high interest rates or high inflation, and they do this without having the power of a reserve currency.
RICH: Japan does not have foreign debt. Virtually all of their debt is domestic. In other words, Japan has high debt like the United States and low interest rates like the United States because Japanese households buy Japanese debt at a higher rate than if they were trying to maximize their wealth.
SMART: Japan has incredible levels of debt. Sure, it may be largely domestic, but they still find people willing to take it. If you look at the debt position of Japan and consider the fact that debt sells perfectly well on global markets for the high prices and low yields that it does implies, at the margin, that demand for Japanese debt is high even though they do not have a reserve current.
RICH: No, you are wrong. Almost all the main owners of Japanese debt are the Japanese central bank and the Japanese population. It sells very little net on public markets. The price of United States debt is high because there is high global demand that prefers the US dollar relative to all other alternatives. The price of Japan debt is high because there is high Japanese demand that prefers Japanese assets even if it means they make less money over all. Saying “at the margin” does not explain anything.
In other words, thinking “at the margin” is not how the brain works. The human brain is a superb pattern recognition machine with a relatively incapacitated memory, a combination that results in familiarity (Japanese people owning Japanese things), popularity (Argentinian and Chinese people owning American things), and recency bias (American things have been more stable throughout history) as the dominant drivers of preference and decision making.
People do not by default stand ready to exploit marginal differences between the price of something and the cost of something. The human brain processes information in terms of average history not the marginal opportunity.
A perfect example of how bad serious leaders are when it comes to thinking at the margin may be found in the either cockeyed optimism or deep zealotry of climate change entrepreneurs. There are now entire industries devoted to stopping natural gas production and planting more trees to “stop climate change”. How could replacing a subset of something compensate for the removal of the entire set? Planting trees to remove carbon dioxide from the atmosphere makes about as much sense as flipping to paper straws to clean the ocean. The marginal effect is non-existent.
The main point is that the emissions of any one year from any one activity such as beef farming or air travel are a negligible fraction of the total sum of human caused emissions since they fired up the Edison Electric Light Station in 1882. If humans and therefore financial and intellectual markets were capable of thinking at the margin, it would be obvious that whatever warming may come in the next 100 years as a result of the last 100 years has already been set in motion.
A marginal impact on the concentration of heat trapping gases in the atmosphere would require a massive amount of nuclear energy and a massive amount of natural gas en route to future of clean electricity made possible by many technologies yet to be perfected. But humans do not think at the margin and so, perhaps, neither should you.
Which is to say, if you assume the world perfectly reflects any and all difference between the marginal cost and the marginal benefit you are as much a source of distortion as those who are not equipped to fathom their own plans for the future. Think at the margin? No thanks. Bad advice. Think on the level of what people really want to believe. It never fails.