A lot of things don’t make any sense. The numbers don’t add up, the explanations are full of holes. And yet they keep happening – people making crazy decisions, reacting in bizarre ways. Over and over.
Historian Will Durant once said, “logic is an invention of man and may be ignored by the universe.” And it often is, which can drive you mad if you expect the world to work in rational ways. A common cause of everything from divisive arguments to bad forecasting is that it can be hard to distinguish what’s happening from what you think should be happening.
Two short war stories to show you what I mean.
The Battle of the Bulge was one of the deadliest American military battles in history. Nineteen thousand American soldiers were killed, another 70,000 missing or wounded, in just over a month as Nazi Germany made an ill-fated last push against the Allies.
Part of the reason it was so bloody is that Americans were surprised. And part of the reason they were surprised is that in the rational minds of American generals, it made no sense for Germany to attack.
The Germans didn’t have enough troops to win a counterattack, and the few that were left were often children under age 18 with no combat experience. They didn’t have enough fuel. They were running out of food. The terrain of the Ardenne Forest in Belgium stacked the odds against them. The weather was atrocious.
The Allies knew all of this. They reasoned that any rational German commander would not launch a counterattack. So the American lines were left fairly thin and ill-supplied.
And then, boom. The Germans attacked anyway.
What the American generals overlooked was how unhinged Hitler had become. He wasn’t rational. He was living in his own world, detached from reality and reason. When his generals asked where they should get fuel to complete the attack, Hitler said they could just steal it from the Americans. Reality didn’t matter.
Historian Stephen Ambrose notes that Eisenhower and General Omar Bradley got all the war-planning reasoning and logic right in late 1944, except for one detail – how irrational Hitler had become. But that mattered more than anything.
A generation later, something similar happened during the Vietnam war.
Secretary of Defense Robert McNamara viewed the world as a big math problem. He wanted everything quantified, and based his career on the idea that any problem could be solved if you obeyed the cold truth of statistics and logic.
One of the key measures of success during Vietnam was body count – how many Viet Cong did American troops kill? Are more Viet Cong dying than Americans? It was easy to track, easy to show on a chart, and became an obsession.
Then there was the logic: If enough Northern Vietnamese were killed, you could break the spirit of the enemy who saw their chances of victory diminished. More enemy bodies was equated with being closer to winning. William Westmoreland, who commanded U.S. forces, explained in 1967:
We’ll just go on bleeding them until Hanoi wakes up to the fact that they have bled their country to the point of national disaster for generations. Then they will have to reassess their position.
The war was turned into a math equation. If enemy dead outnumbered American dead, Americans would win. Ice-cold logic.
But the bodies piled up, and the war went on. And on. And on.
The “equation” would work only if the North Vietnamese leaders were calm, rational actors who would “calculate costs and benefits to the extent that they can be related to different courses of action, and make choices accordingly,” as one paper put it.
But they weren’t.
Edward Lansdale of the CIA once told McNamara that his statistics were missing something.
McNamara said, “What?”
Landsdale said, “The feelings of the Vietnamese people.”
You couldn’t capture that on a chart. But it meant everything. In 1966 New York Times reporter Harrison Salisbury wrote:
I seldom talked to any North Vietnamese without some reference coming into the conversation of the people’s preparedness to fight ten, fifteen, even twenty years in order to achieve victory. At first I thought such expressions might reflect government propaganda … but … I began to realize that this was a national psychology.
Ho Chi Minh put it more bluntly: “You will kill ten of us, and we will kill one of you, but it is you who will tire first.”
That’s exactly how it played out in America, where statistics meant nothing against feelings.
Westmoreland once told Senator Fritz Hollings, “We’re killing these people at a rate of 10 to one.” Hollings replied, “The American people don’t care about the 10. They care about the one.”
That was hard to reconcile in the statistical mind of someone like McNamara. It was like defying the laws of physics, or a typo in a math equation.
But that’s how the world works.
Some things just don’t compute.
Investor Jim Grant once said:
To suppose that the value of a common stock is determined purely by a corporation’s earnings discounted by the relevant interest rates and adjusted for the marginal tax rate is to forget that people have burned witches, gone to war on a whim, risen to the defense of Joseph Stalin and believed Orson Welles when he told them over the radio that the Martians had landed.
That’s always been the case. And it will always be the case.
One way to think about this is that there are always two sides to every investment: The number and the story. Every investment price, every market valuation, is just a number from today multiplied by a story about tomorrow.
The numbers are easy to measure, easy to track, easy to formulate. They’re getting easier as almost everyone has cheap access to information.
But the stories are often bizarre reflections of people’s hopes, dreams, fears, insecurities, and tribal affiliations. And they’re getting more bizarre as social media amplifies the most emotionally appealing views.
A few recent examples of how powerful this can be:
Lehman Brothers was in great shape on September 10th, 2008. Its Tier 1 capital ratio – a measure of a bank’s ability to endure loss – was 11.7%. That was higher than the previous quarter. Higher than Goldman Sachs. Higher than Bank of America. It was more capital than Lehman had in 2007, when the banking industry was about as strong as it had ever been.
Seventy-two hours later it was bankrupt.
The only thing that changed during those three days was investors’ faith in the company. One day they believed in the company. The next they didn’t and stopped buying the debt that funded Lehman’s balance sheet.
That faith is the only thing that mattered. But it was the one thing that was hard to quantify, hard to model, hard to predict, and didn’t compute in a traditional valuation model.
GameStop was the opposite. The statistics showed it was on the edge of bankruptcy in 2020. Then it became a cultural obsession on reddit, the stock surged, the company raised a ton of money, and now it’s worth $11 billion.
Same thing here: The most important variable was the stories people told and the emotions they suddenly stumbled upon. And that was the only thing you couldn’t measure and couldn’t predict with foresight. That’s why the results don’t compute.
Whenever something like this happens you see people shocked and angry about how the market has become detached from fundamentals.
But Grant was right: It’s always been like this.
The 1920s were giddy. The ‘30s were pure panic. The world was coming to an end in the ‘40s. The fifties, ‘60s, ‘70s, were boom to bust, over and over. The ‘80s and ‘90s were insane. The 2000s have been like a reality TV show.
If you’ve relied on data and logic alone to make sense of the economy you’ve been confused for 100 years straight.
Japan is offering companies a 40% tax rebate to raise wages. But most companies aren’t, in part because raises just aren’t part of the Japanese business culture.
Meanwhile, JPEGs of apes have risen in value several thousand percent in the last few months, in part because that is part of the crypto culture.
Economist Per Bylund tweeted this recently:
The concept of economic value is easy: whatever someone wants has value, regardless of the reason (if any), and its value is higher the more it’s wanted and the less there is of it.
Not utility, not discounted cash flow – just whether people want it or not, for any reason. So much of what happens in the economy is rooted in emotions, which can, at times, be nearly impossible to make sense of.
To me it’s obvious that the one thing you can’t measure, can’t predict, and can’t model in a spreadsheet is the most powerful force in all of business and investing – just like it’s the most powerful force in the military. Same in politics. Same in careers. Same in relationships.
A lot of things don’t compute.
The danger, and you see it often in investing, is when people become too McNamara-like – so obsessed with data and so confident in their models that they leave no room for error or surprise. No room for things to be crazy, dumb, unexplainable, and to remain that way for a long time. Always asking, “Why is this happening?” and expecting there to be a rational answer. Or worse, always mistaking what happened for what you think should have happened.
The ones who thrive long term are those who understand the real world is a neverending chain of absurdity, confusions, messy relationships, and imperfect people.
Making sense of that world requires admitting a few things.
John Nash is one of the smartest mathematicians to ever live, winning the Nobel Prize. He was also schizophrenic, and spent most of his life convinced that aliens were sending him coded messages.
In her book A Beautiful Mind, Silvia Nasar recounts a conversation between Nash and Harvard professor George Mackey:
“How could you, a mathematician, a man devoted to reason and logical proof, how could you believe that extraterrestrials are sending you messages? How could you believe that you are being recruited by aliens from outer space to save the world?” Mackey asked.
“Because,” Nash said slowly in his soft, reasonable southern drawl, “the ideas I had about supernatural beings came to me the same way that my mathematical ideas did. So I took them seriously.”
The first step to accepting that some things don’t compute is realizing that the reason we have innovation and advancement is because we are fortunate to have people in this world whose minds work differently from yours. Beyond Nash are people like Elon Musk and Steve Jobs, whose personalities are equal parts brilliant and absurd, and the absurd can’t be separated from the brilliant – you have to accept the full package. We’d never get anywhere if everyone viewed the world as a clean set of rational rules to follow.
The next is accepting that what’s rational to one person can be crazy to another. Everything would compute if everyone had the same time horizon, goals, ambitions, and risk tolerances. But they don’t. Panic selling stocks after they’ve declined 5% is a terrible idea if you’re a long-term investor and a career imperative if you’re a professional trader. There is no world in which every business or investing decision you see should align with your own view of the world.
Third is understanding the power of incentives. Bubbles are technically irrational, but the people who work in bubbles – mortgage brokers in 2004 or stockbrokers in 1999 – make so much money from them that there’s a powerful incentive to keep the music playing. They delude not only their customers, but themselves. Nothing gets people to look the other way like easy money.
Last is the power of stories over statistics. “Housing prices in relation to median incomes are now above their historic average and typically mean revert,” is a statistic. “Jim just made $500,000 flipping homes and can now retire early and his wife thinks he’s amazing” is a story. And it’s way more persuasive in the moment. If you look, I think you’ll find that wherever information is exchanged – wherever there are products, companies, careers, politics, knowledge, education, and culture – you will find that the best story wins. Great ideas explained poorly can go nowhere while old or wrong ideas told compellingly can ignite a revolution.
Novelist Richard Powers put it: “The best arguments in the world won’t change a single person’s mind. The only thing that can do that is a good story.”
It’s hard to compute, but it’s how the world works.