Intellectual Dishonesty

"I play the stock market of the spirit and I sell short."
--Ellsworth Toohey (The Fountainhead)

Interesting profile in the New Yorker of Ray Dalio, founder and CEO of Bridgewater Associates. Bridgewater is the world's largest hedge fund operator with about $90 billion under management. His story and his firm's approach are worth pondering. Here, however, I'd like to focus on the journalistic approach in the piece--an approach that is typical of the New Yorker and similar outlets.

The article's tone could be deemed 'classic intellectual,' as the author is prone to peering down his nose with normative disdain at Dalio and Bridewater's approach. For instance, the author seems to question Bridgewater's 'cult-like' environment and Dalio's lists of rules and principles that tend to 'weed out' people who are not good fits with the culture.

What the author fails to realize/acknowledge is that there is a large body of research (e.g., Collins & Porras, 1994) linking high performing organizations to ideosyncratic, cult-like workplaces that are not necessarily inclusive or fun places to work. The Bridgewater environment certainly seems quirky and not for everyone. But it is likely that this cultural uniqueness contributes to the firm's strategic success.

Near the end of the article, after quoting Dalio as saying that earning more than the average market return is 'zero sum,' the author predictably questions the 'social utility' of hedge funds. His argument is that if there is not a net positive sum, then maybe the hedge fund industry does not have a valid 'social purpose.' After all, the author states, hedge funds attract many of the best and brightest away from other, presumably more productive, endeavors.

The author once again demonstrates his ignorance on a number of counts. While battles between hedge funds for 'alpha,' or excess market returns may be zero sum (i.e., gains for one firm come out of the hides of other firms), the markets that these firms operate in are not zero sum. For example, hedge funds add volume that would not be there otherwise, thereby narrowing spreads and improving liquidity. More importantly, buyers and sellers would not engage in trade unless each side perceived itself as better off. Markets facilitate positive sum transactions. Bridgewater, for instance, has been a big buyer of Treasuries over the years. Where would the US, the largest issuer of debt on the planet, be without such big buyers? As Dalio correctly observes, the hedge fund industry contributes to the efficiency of the capital allocation process.

Moreover, the author seems oblivious to the reality that hedge funds would not exist without demand for what hedge funds do. I mean, clients have given Bridgewater $90 billion to manage. This is the typical intellectual perspective that views producers with scorn while totally ignoring the market principle that supply follows demand. In markets, buyers rule, not the sellers. Yet the intellectual set continues to fantasize that producers are somehow putting guns to buyers' heads and forcing them to buy, and society is worse off as a result.

Forced consumption can only occur in socialist economies. Socialism removes buyer choice from the equation, relying instead on the 'wisdom' of central planners to determine how economic resources are allocated. Ironically, socialism is precisely the direction that intellectuals generally believe to be righteous.

Schumpeter (1942) famously observed that capitalism drives a 'process of creative destruction.' where producers are obsoleted by other firms who develop better ways to satisfy customers. From the producer's standpoint, any industry may seem 'zero sum' if producers are ultimately destined to hand over the reigns to other producers. One competitor's gain can be seen as another competitor's loss. The sure fire winner in this process, however, is the consumer. The competitive process generates goods and services that raise standards of living across the social spectrum.

The author does correctly point out that hedge funds generally operate with significant leverage to 'magnify their bets. However, he then implicates that hedge fund leverage in the collapse of Bear Stearns and Lehman when funds pulled capital en masse from banks during the meltdown. The author fails to mention that pulling capital requires that the hedge fund first unlevers, and that Bear, Lehman were (and many still are) operating at leverage ratios of 30:1 or more. He also ignores the fact that institutions like Bear, Lehman, et al are the source of hedge fund leverage. A fund can only get levered if can find a creditor that is willing to lend at an interest rate that is attractive.

If the author really wanted to approach the root cause of the market bubbles he seems to think are blown by hedge funds, then he should be asking about where all the cheap credit comes from that provides the fodder for leverage throughout the financial system.

position in SPX

References

Collins, J.C. & Porras, J.I. 1994. Built to last. New York: Free Press.

Schumpeter, J.A. 1942. Capitalism, socialism, and democracy. New York: Harper & Brothers.