When one ignores the civilised market system...

Nov 19, 2014

New York, New York

Dear Diary,

Want to know the secret of success in today's modern, civilized world? Be civilized.

More on that in one moment.

First, the Dow hit a new high yesterday after rising 40 points. Gold is moving back up to $1,200...appearing to have bottomed out. Time will tell. Remember that gold is not an investment. It is just money. The best money. You keep some on hand; you never know when you might need it.

Now, back to the secret of success.

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In 1962, Robert Axelrod was still a student. But he had access to the University of Michigan's only computer - a primitive, clunky machine. Students were just beginning to figure out what to do with computers. And Axelrod's idea was to program it to play a game.

The game was meant to resolve what is known as 'the prisoner's dilemma.' You and a friend get busted for drugs. If you both keep your mouths shut you will probably both walk away. But if one rats out the other, the first will go free and the other will do time. If you both turn on each other, both of you will do time...but probably not as much, since you have both cooperated with the prosecution.

You are in separate cells, being sweated privately. What to do?

The question is not just theoretical. In many situations - business and personal - you have to make a decision about what to do. Be 'nice' to the people you deal with or to look out for Number 1, regardless of the consequences to others? In a divorce, for example, do you try to get the most you can get...or work together for the best outcome for both? What's the best strategy?

A whole subculture of logicians arose trying to answer this question. Inevitably, the geeks were pulled into action. Axelrod developed algorithms to model the choices by computer. One was always nasty (which he called 'Lucifer.') One was always nice (which he called 'Jesus'). Others were more complicated.

The game was played over and over again, allowing the programs to modify their behavior depending on the reception they received. Which was most successful? A program called GTFT, Generous Tit for Tat. It always opened like a saint, with a generous move. And if it was met with a nasty move, it retaliated like a sinner, with nastiness of its own. One time out of ten, though, it answered nastiness with undeserved generosity.

GTFT is a stick-figure version of how you succeed in modern civilization. You are nice. You expect others to be nice. And you retaliate when they're not. It works, more or less well, on a personal level. And it works in an economy.

We have already seen why command economies do not work; they are not very nice.

Instead of the "Do Unto Others" of a market economy, everyone is forced to take what he is give. There is no room for tit or tat; central planners tell everyone what to do. But they never have enough information or bandwidth. They don't know what producers can produce nor what consumers want. They try to compensate for ignorance of the specifics by putting people into categories...proletariat, bourgeoisie, rich, poor, young, old...whatever seems convenient at the time. And they simplify both quantity and quality with heavy handed statistics that are largely meaningless. Thus in one famous example from the Soviet Union, central planners gave the nail producers their quotas in terms of weight. Their work assignment had nothing to do with what customers wanted; they were required to produce a pre-determined number of pounds of nails. They met their quotas by producing huge, largely unusable 10-lb spikes. Then, realizing the problem, the planners switched to a quota based on the number of nails produced. This led manufacturers to a produce millions and millions of tiny pins.

Once you ignore the civilized market system - in which people come to terms with one another voluntarily, tit for tat - you are headed for trouble. The Soviet Union provided us with a case study over a 70-year period, involving approximately 300 million unwilling participants. The results were conclusive: command economies cannot compete with market economies, for reasons explained by Friedrich Hayek 80 years ago in his "The Fatal Conceit."

Hayek was talking about economics. Porter's insight was that the same principle applies to individuals in their personal and business lives.

All transactions - in business, career, love, and daily commerce - are based on mutual advantage. You can't expect to get without giving. Yes, you can bully. You can threaten. You can deceive. You may get what you want...for a while. But it is the win-win deal that keeps friends and customers happy. It's the generous tit for tat program that works.

But that's not the end of the story. As the computer models kept playing the game, GTFT evolved. The less often it retaliated, the better it worked. The parallel in the real world is obvious. The more trust in a society, the more efficient its tit for tat games become. When you can trust your counterparties to do the right thing, you don't need to pay for security, verification, audits, police, courts, surveillance, lawyers, and other costs of protection and enforcement.

But the more you let down your defenses, the more you lay yourself open to nasty surprises. As the computer models happily played 'Jesus,' a rogue program - resembling 'Lucifer' - attacked. The whole system broke down.

Lesson? Be generous. Be nice. But keep some gold, just in case.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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