<nettime> Gilder: The Confidence Game

["R. A. Hettinga" <rah@shipwright.com>]

http://www.forbes.com/forbes/2002/1223/234_print.html

 Forbes.com


Forbes 85th Anniversary
The Confidence Game
George Gilder, 12.23.02

Why I trust the most disgraced chief executive more than I do the most
reputable public servant.
George Gilder
Why do I trust Gary Winnick and Jeffrey Skilling--nefarious former chief
executives of notoriously bankrupt companies--more than I trust Senator
John McCain of vaunted valor in prison camps or David Broder of Pulitzer
fame or Senator Joseph Lieberman of famously flinty integrity? Why do I
trust Kenneth Lay of {Enron (otc: ENRNQ - news - people ) and Bernard
Ebbers of {WorldCom (otc: WCOEQ - news - people ) more than I trust
Justices William Rehnquist and Antonin Scalia, the stalwart intellectual
leaders of a nominally conservative Supreme Court, or even George W. Bush,
that most trusted of Presidents?

Why do I trust General Electric (nyse: GE - news - people ) chief emeritus
Jack Welch or AT&T (nyse: T - news - people ) Chief Michael Armstrong more
than I trust the entire scientific and environmental coverage in the New
York Times and all the venerable editors of the increasingly political
Scientific American? Why do I trust Martha Stewart and ImClone (nasdaq:
IMCL - news - people )'s Sam Waksal far more than I trust the crusading
journalist James B. Stewart or New York State Attorney General Eliot
Spitzer, trustbuster deluxe, as they righteously seek to banish
moneylenders, marketmakers and conflicts of interest from the temples of
Wall Street?

The reason I trust disgraced executives more than politicians, judges and
journalists is the same reason that I trust physicists more than I trust
sociologists. The answer comes from the eminent philosopher of science Karl
Popper: falsifiability. In science, falsifiability means that a hypothesis
is presented with sufficient rigor to be proven wrong, that is, falsified.
It is the condition of trust. By contrast, the sociologist deals in broad
propositions--such as "ethnic diversity improves educational outcomes" or
"patriarchy causes war"--that, by sinking into a mush of definitions, defy
disproof.

Except when conducting trials of identifiable crimes such as murder or
assault, judges are no more truthful than politicians or journalists. They
all adhere to the "ring-true" standard of sociology rather than the
falsifiable standard of physics. Most of the time, as physicist Wolfgang
Pauli put it in another context, they are not even wrong. Their statements
lack the rigor to rate as lies and swim in the ontological soup of the verb
"to be." From such a soup, no enduring truths can evolve.

Like a physical experiment, every entrepreneurial venture embodies and
tests a hypothesis about products or markets. Intel is currently preparing
to test the hypothesis that computer companies will choose a microprocessor
that runs at 3 gigahertz, or 3 billion cycles a second, and will buy it in
sufficient volumes that Intel can profitably manufacture it in a plant that
costs $2 billion to build and equip. Samsung is testing whether people will
buy a cell phone that takes digital photographs. Ebay (nasdaq: EBAY - news
- people ) is testing whether it can move beyond Web auctions of used wine
openers to Web auctions of $20,000 antique cars, and to TV programs. The
presence of such testable hypotheses distinguishes investment from both
gambling and government planning. A true gamble does not test a refutable
principle. Therefore it cannot produce valuable knowledge. Likewise, a
nationalized business with guaranteed markets cannot yield falsifiable
information.

Knowledge emerges not from chaos, or fixity, but from conditions of
uncertainty. Under capitalism power flows to precisely the people who are
willing to stake their money not on gambles or sure things but on testable
hypotheses, thus generating knowledge and wealth for society. Entrepreneurs
are trustworthy because they accept a moral code of testability and
falsifiability rather than one based on sentiment, sanctimony, good
intentions, good press, good luck, good looks or guarantees.



Bankruptcies play the same role in economic progress that falsifiability
plays in the progress of ideas. Both sciences and businesses advance as
much by disproof as by affirmation. Every capitalist investment has the
potential for a dual yield: a financial profit and an epistemological
profit. One without the other is sterile. Economies progress when the
process of investment is informed by the results of previous investments.
What makes the entrepreneur uniquely trustworthy is that he combines in one
person these two yields of enterprise. If his venture succeeds, he also
gains the power--through profits--to make further investments, further
experiments in light of his initial venture. If his venture fails, he and
other investors who shared his confidence in the business may well lose
wealth, and the project will sooner or later be halted, no matter how
commendable and morally uplifting it is. But even as money is lost,
epistemological profit is gained, distilled through the learning effects of
direct experience.

I trust chief executives because they deal in projects that can go
bankrupt. They cannot repeatedly or consistently lie about their companies
because the truth will out in a relatively short time. Even at Enron, Lay
and Skilling could deceive themselves and the public only for a matter of
months. Skilling got skittish--and got out. Lay maintained his faith
through no fewer than 14 margin calls that he had to meet by selling Enron
shares. Both Enron stars learned their lessons (about off-the-books
subsidiaries and financial engineering, for example), and they taught them
to the world.

Gary Winnick and his serial executives at Global Crossing (otc: GBLXQ -
news - people ) also submitted to the crucible of experience. Building a
unique global network of optical fiber, they learned the perils of debt in
a deflationary market. Selling a quarter of his shares at a $600 million
profit, Winnick also signaled a belief that they were fairly valued or even
overvalued. Many other shareholders did not trust that signal, though they
should have. Now politicians want to banish such information from markets
altogether in the name of making them more transparent and trustworthy. But
most business information is uncertain most of the time. Which means that
bans on insider trading make markets more treacherous, since prices will
not move until outcomes are sufficiently certain to be announced. Insider
trading rules make the executive personally liable for getting things
wrong, though much of what any chief executive--or any person--thinks at
any particular time is wrong. Thus the law bars all the guesses and
intuitions of people closest to the company from influencing the price of
the shares.

While executives can be trusted to face reality and learn from it, even if
it means bankruptcy, no such corrective faced the politicians and judges
who allowed the bankruptcies of some 35 onetime producers of asbestos on
account of preposterous claims of "potential illnesses" from this mostly
safe and useful material. No such edifying gauntlet faced the government
officials and politicians who brought down 70 telecom companies through a
series of egregious policy errors of telecom reregulation and monetary
deflation.

Politicians are indignant about bankruptcy. They deem it a crime, rather
than a punishment. But they would never tolerate the equivalent outcome for
themselves. To prevent such a catastrophe, incumbent politicians such as
McCain and Lieberman, who want us to trust them, have been busily enacting
campaign-finance rules that bar anyone without a personal fortune from
displacing them. But even the loss of an election does not require the
abnegation faced by a bankrupt entrepreneur, or the recanting expected of a
scientist whose findings have been falsified. Coming from an entirely
different culture, politicians and journalists are baffled by enterprise
and science. But the most crucial reason to distrust nearly everything said
by politicians is their defiance of truth and reality on issues of science.



Example: In one of the most brazen chemophobic claims in the history of
science and government, politicians around the world are now condemning
carbon dioxide (the air that we breathe out and plants imbibe) as a
dangerous pollutant. Seeking new controls on the global economy, Greens
urge implementation of the Kyoto Protocol on global warming, which would
cost $500 billion a year to apply, reliably causing a Third World holocaust
of famine and poverty. Citing a nonexistent consensus of scientists, the
political choirs ignore all evidence that temperatures today, though
admittedly warming up from the "little ice age" of the last millennium, are
cooler than their average in the human era. By many paleochemical
calculations, corroborated by historical record, global temperatures were
several degrees warmer 1,000 years ago, 3,000 years ago and 6,000 years
ago, long before humans began using fossil fuels. Rushing to justify new
government powers over the global economy, journalists and politicians
simply do not deign to consider the available data on the history of
weather.

Politicians get away with denouncing reality and blaming it on executives
and other private-sector powers. But driving most of the misrepresentation
in business is the labyrinth of laws through which the chief executive has
to guide his company, following the advice of lawyers and accountants and
sharpie chief financial officers. Since corporate tax laws and securities
regulations make no sense, executives do not bother to learn the details,
leaving interpretation of the cabalistic codes to highly paid experts with
many years of training and specialized degrees. Journalists who would never
dream of filling out their own tax returns deride executives who claim they
have no clear idea of the contents of thousands of pages of mandated forms
and accounts that remain unread by anyone, including the government bodies
that mandate them--until bankruptcy or recession lends 20-20 postmortem
clairvoyance to press, politicians and prosecutors. Depreciation rules that
assign lives of 15 years to telecom switches that grow obsolete in 15
months make "the capitalization of expenses" a mandatory part of telecom
business. Mandatory, that is, when the government mandates it. Otherwise,
as in the case of WorldCom, it becomes felonious. As the President put it,
"Corporate accounting is not necessarily black and white."

What makes these accounts so critical to politicians are insider trading
regulations that try to create a level playing field for both a taxi driver
and Warren Buffett. With all other information pushed beyond the pale,
politicians want to believe that the quarterly numbers are meaningful and
sufficient guides to investment. But without inside information of material
significance, investment loses its falsifiable basis and becomes a form of
gambling. Buffett or the executives of General Electric or the masters of
Silicon Valley's venture capital would never think of staking their funds
without inside knowledge unavailable to hoi polloi. Inside knowledge is
perfectly legal for all these players, who sit on multiple boards, read
hundreds of for-their-eyes-only business plans, and shuffle capital among
hundreds of companies under a corporate umbrella or within a portfolio.

The law denies inside information only to the layman, who is expected to
invest on the basis of technical analysis (the voodooistic interpretation
of past trading patterns), Keynesian economic astrology, quarterly earnings
reports known to the world and other trading trivia. While investigators
pore over tomes of paperwork to ferret out the possibly inside provenance
of information about ImClone--which had already plunged the stock ten
points when Martha finally sold--the rest of the world is left to
contemplate the baffling challenge of finding any shred of actionable data
about a company that cannot be deemed an inside tip. The idea of a level
playing field of information is ridiculous on its face, since information
is defined as a deformation of the level. Outside analysis is mostly
useless to investors--because it is outside, and thus widely known and
already reflected in the prices of shares.



Chief executives understand that it is impossible to banish insider trading
without crippling the markets themselves. They grasp that conflicts of
interest are ubiquitous in life and that intelligent people take them into
consideration when appraising a particular report, tip, argument or
analysis. But politicians rule a realm where rhetoric trumps reality, where
they imagine they can guarantee corporate purity with Chinese walls and
chastity belts among analysts and bankers, forced recusals by "interested
parties," mandated "independent" board members, executive seals and
signatures on all accounts, back-checks and other fake remedies imported
from the world of law and politics. Amid the fun-house mirrors of insider
trading rules, we now live in a world where the only investors free of
suspicion are people who channel their money into companies they know
nothing about. Approved by politicians everywhere, the best investment by
this measure is a state-run lottery or, more significantly, an all-market
index fund from which all useful inside information has been excluded. If
people are not allowed to put their money in companies they understand,
capitalism loses its advantage over socialism, since what makes capitalism
succeed is the assignment of capital to the insiders who earned it--and
thus learned how to invest it profitably.

The insanity of our securities laws, and even our tax laws, is nothing
compared with the sand thrown into capitalism's gears by American antitrust
law. Based on the idea of perfect competition, where the market is
omniscient, this code is as unenforceable as the insider trading rules. Now
coming forward with treble-damage antitrust claims are the likes of class
action attorney William Lerach. Under the rules, companies today can set
any price they choose for their output, as long as it is not too high
(gouging), too low (predatory dumping) or just right (collusion). At
present Micron Technology (nyse: MU - news - people ) and other producers
of dynamic random access memory chips for computers--one of the most
competitive industries on the planet--are confronted with charges from the
Justice Department that imply all three pricing offenses at once.

No government program has ever gone broke, which is why politicians need
never face the inconvenience of weighing the truth or falsity of their
claims while they calibrate them to the resonant frequencies of their
audiences. Republicans were cruelly unfair to Bill Clinton, whom they
assailed as dishonest, when in fact he was fully honest to his trade as a
Democratic politician. Republicans are scarcely better. They adopt a
different idiom, oriented toward people in businesses, churches,
constabularies and intact families, rather than toward single mothers,
academics envious of others' success, union members, government workers,
criminals and professional Greens or grievance groups. But politicians in
neither party tell the kinds of truths espoused by physicists.

When a politician breaks the pattern and speaks the truth--normally in a
crisis too sudden to permit the conducting of a public opinion poll--he
gains instant beatification, as Rudy Giuliani and George W. Bush discovered
after Sept. 11. The public reels in amazement and admiration, as if their
dog had begun to sing Schubert lieder. After a time, though, the politician
wishes to discover what it was that elicited the public enthusiasm. He
takes a poll.

Chief executives trust the personal opinions of their customers, who
voluntarily and authoritatively choose what to buy with their own money.
Politicians collect the money of others in order to spend it on public
purposes sanctioned by figments of aggregate opinion.

In a profession offering a limited number of powerful slots--100 senators,
50 governors, 1 President--politicians live in a zero-sum world, where the
gains of one necessarily come at the expense of others. In an election, one
candidate wins and the other loses. In a zero-sum world, you may envy or
blandish others, but you cannot trust them, because you can assume they are
seeking to aggrandize themselves at your expense. Thus politicians
necessarily distrust one another and the public. It is natural for them to
tax and regulate people coercively.

By contrast, chief executives know that their success is dependent on
grasping a reality that they can never comprehend in its fullness
themselves. In order to win they must trust others and collaborate with
them. Their success depends on the successes of others; their own
enrichment relies upon the enrichment of their customers and collaborators;
their own profits stem from the dignity of voluntary personal choices,
rather than coercive appropriations. Their entire enterprise is ultimately
founded on trust. That is ultimately why I trust them. They trust me.

-- 
-----------------
R. A. Hettinga <mailto: rah@ibuc.com>
The Internet Bearer Underwriting Corporation <http://www.ibuc.com/>
44 Farquhar Street, Boston, MA 02131 USA
"... however it may deserve respect for its usefulness and antiquity,
[predicting the end of the world] has not been found agreeable to
experience." -- Edward Gibbon, 'Decline and Fall of the Roman Empire'

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