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Wednesday, 22 September 2010

Eat Your Stocks

Much Ado About Nothing?

Scientists study stuff which exist: physicists the physical laws of nature, biologists the nature of life and psychologists the human mind. Economists, on the other hand, study money: which is surely a figment of the human imagination.

Given the ephemeral nature of the subject it’s a wonder that there’s any mileage in spending any effort on the subject at all, but huge amounts of time and money are expended in doing so. So if money is fundamentally unreal, what the hell is economics all about?

Monkey Money

At the end of Superfreakanomics, is a piece about researchers attempting to teach monkeys the value of cash. The book is, like its predecessor, wildly entertaining, although its authors make amusing attempts to distinguish its topic of microeconomics from its recently discredited big brother macroeconomics. Which makes it all the more interesting that it ends on a study with direct macroeconomic implications.

The study referenced is How Basic are Behavioral Biases? in which Chen, Lakshminarayanan and Santos investigate how capuchin monkeys react to being taught to use tokens in exchange for food. By doing so the researchers were able to show that the monkeys exhibit the classical signs of loss aversion, from which they impute that the psychology of this is innate rather than learned: after all, the monkeys have no prior experience of trading:
“We have argued that finding behavioral biases in capuchin choice can suggest an early-evolutionary origin for these biases in humans … since primates and humans are closely related, it is unlikely that a common trait evolved in parallel between our two species, and much more likely that common traits evolved once during our common evolutionary heritage.”
Money is Food

Well, maybe. Capuchin and human ancestors split from each other around 30 million years ago so, if correct, this suggests that loss aversion has a very long evolutionary pedigree. As an alternative explanation, parallel evolution of usefully adaptive traits isn’t uncommon either because there are only so many ways of solving certain problems: bats and birds both evolved wings, but they aren't even close cousins. However, what really interested me about this is that way that the researchers introduced the concept of money to the monkeys: by linking it to food.

Now this isn’t the first time that the link between money and food has been made. After all, if you look at the long course of human history for most of it not only did we not have any kind of money but we didn’t have any clothes to keep it in. Yet we always needed to acquire food in order to keep ourselves alive. If you turn many of the famous behavioural finance experiments from questions about money into questions about food you get some interesting results.

Recasting Prospect Theory

For instance: here’s the classic experiment of Prospect Theory recast in terms of a couple of choices about food. In the first one we have an 80% probability of getting food every day for the next forty days and a 20% probability of getting nothing. In the second one we have a 100% probability of getting food for the next thirty days. Which would you choose?

According to economists the only sensible answer is to go for the 40 day option, since it’s statistically more likely to ensure we get the best deal. According to everyone else 20% of economists die every month, wondering why all the mammoths have migrated North. If we’re dealing with food rather than money the standard economic view is not just irrational, it’s clearly and wantonly stupid.

The Properties of Money

Of course, the idea that our financial desires stem from evolutionary preferences for food makes intuitive sense. Food was probably the most important thing in the daily lives of proto-humans while money was not so much irrelevant as unknown. And, of course, it’s interesting that the capuchin study trains the monkeys to use money by using food as a reward – what else would you use?

However, food and money have different properties. They’re not actually equivalent, most of the time. As described in The Evolutionary Origins of Human Patience:
“Humans are more willing to wait for monetary rewards than for food, and show the highest degree of patience only in response to decisions about money involving low opportunity costs”.
In essence, the way that humans respond to financial incentives is different to the way that we respond to food related ones. This isn’t that surprising because they have different properties. After all, you can’t eat money and even if you get money that you can exchange for food you generally can’t do it instantly.

Perishable Commodities

Although money isn’t immediately consumable it also isn’t immediately perishable either. Stored food, on the other hand, had a tendency to rot prior to the nineteenth century invention of refrigeration. Money also rots through inflation but, generally, it can be used as a store of value with which to acquire that which we need at a later date. Which will often entail food, of course.

However, at the limit, even for humans, money and food become exchangeable. It’s rare that this happens but occasionally money becomes as perishable as food. This occurred in 1920’s Germany and more recently in Zimbabwe when hyper-inflation meant that the value of the currency in your pocket could collapse while you were walking down the street. As soon as people got any money at all they rushed to exchange it for the essentials of life – principally food. At the limit money equals food.

Money’s Not in the Genes

Outside of this though, it’s simply not likely that the human love of money is purely an evolutionary adaptation:
“…money has emerged only in the last 3,000 years or so, too short a time for significant genetic adaptation to its existence; besides, individuals born into cultures that have never used money quickly come to use it if they come into a money-using culture”.
There are multiple alternative theories about how we came to desire money. Tool Theory argues that the sheer usefulness of money is why we come to use it so quickly – it’s simply a tool like any other that we use, and none of those are mediated by biology, they’re cultural artefacts. There’s also Drug Theory which suggests that money acts as a stimulant to brain areas associated with immediate rewards: which is obviously related to associating it with food.

Although these theories can generally be seen as opposed there’s also the idea that both are at work. Tool Theory requires higher brain function and thoughtful decision making while Drug Theory operates at a more automated level and is a more straightforward stimulus-response process. This kind of dual model of brain function is something we've seen several times before – see Stocks Aren't Snakes, for example.

When Stocks are Food

None of which leaves us hugely the wiser, but all of which suggests that our reactions to money are probably less directly to do with evolution and more to do with existing neural systems being co-opted to use a tool – money – which is both highly useful and potentially addictive. Just like investing, really. So it wouldn’t be at all surprising therefore to discover that there are situations – like the German Weimar Republic in the 1920’s or the stock market crashes in the 2000’s – where people’s behaviour with money or shares tend to look like their behaviour with other, more essential items like food: turn them into consumables as fast as possible. Basically, eat your stocks.

It’s not the whole truth and probably not even a major part of it, but that underlying our strange behaviour in the face of financial uncertainty are old fears about living with uncertainty about where our next meal is coming from isn’t a great leap. What it doesn’t do is prove that we have any direct evolutionary adaptation to money. We almost certainly don’t – we’re still just apes trying to figure out how best to bang the rocks together. Just try not to get your thumb trapped while you’re doing it.

Related articles: Adam Smith's Monkey Business, The Neuroeconomics Revolution, Darwin's Stockmarkets


  1. “ According to economists the only sensible answer is to go for the 40 day option…”

    Economists have studied now-or-later preferences for many decades, while financial economists simply can't work without it, AND the risk aspect. (See fr'instance Markowitz's Nobel work done in the 50's.) In the financial space, the term of art is one's "utility funciton," or how much (more or less) certainty is worth.

    Not to mention that a lot of work on the named theories are in the behavioral economics and behavioral finance areas.

    So the claim is bullsh*t.

  2. psychologists are scientists???

  3. I recall a related article from New Scientist. Unfortunately, I see it's subscriber-only now.

    Among the points was that money seems to link to primal parts of the brain - just touching money can reduce physical and social pain. References to Daniel Ariely, Barbara Briers, and others.

  4. Political economics links desire for money with the development of capitalism when it entered into industrialism and urbanisation. It is important to understand that this move was forced onto population by governments (elites) which were looking to fight and conquer territories in Europe. For this they needed industrial society able to produce heavy arms as technology became ready. And for this they needed people who would work at factories as well as fight. These people agreed to work and fight because they were forcefully urbanized and therefore lost natural access to food. And therefore they strived to get money which would buy them food. The old agricultural society did not need any money and was pretty much barter based.