The Zurich Axioms By Max Gunther
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Beware the Historian’s Trap
The Historian’s Trap is a particular kind of orderly illusion. It is based on the age-old but entirely unwarranted belief that history repeats itself. People who hold this belief – which is to say perhaps ninety-nine out of every hundred people on earth – believe as a corollary proposition that the orderly repetition of history allows for accurate forecasting in certain situations.
Thus, suppose that at some time in the past, Event A was followed by Event B. A Couple of years have gone by, and now here we are witnessing Event A again. “Aha!”, says nearly everybody, “Event B is about to happen!”
Don’t fall into this trap. It is true that history repeats itself sometimes, but most often it doesn’t and in any case it never does so in a reliable enough way that you can prudently bet money on it.
The consequence of the Historian’s Trap are usually trivial. “Whenever they’re ahead at the end of the third inning, they win the game.” “Every time we meet for a drink, she gets into an office crisis and turns up late.” “Nobody has ever lost the New Hampshire primary and won the Presidency.”
People are always letting themselves be tricked by such unreliable expectations – which may be silly but isn’t often dangerous. But when your money is involved, the Historian’s Trap is dangerous, for it can wipe you out.
The trap is ubiquitous in the financial-counseling business. One might think most counselors would have learned to avoid it after observing time and again that events rarely happen the way they are expected to happen. But no – the illusion of order, or perhaps the need to believe in order, is too strong.
There are whole schools of thought around Wall Street that are based on fundamental fallacies arising out of the Historian’s Trap. Sock and bond analyst will go back to the last time there was a bull market in a certain security or group of securities and collect great baskets of facts on everything that was happening around that time. They will observe that the GNP was rising, interest rates were falling, the steel industry was having a profitable year, the insurance business was in a slump, the White Sox were in the cellar, and the President’s Aunt Matilda had a cold. Then they will wait until the same configuration of circumstances comes together again. “Hey wow!” they will shout when the portentous constellation appears. “Look! Everything is in place! A new bull market is on the way!”
Maybe it is. And maybe it isn’t.
Frank Henry knew a young woman who fell into the Historian’s Trap headfirst and nearly perished there. She worked for the Swiss Bank Corporation in a lowly, ill-paid clerical job, and when she inherited a little mound of capital on her father’s death, she resolved to invest the money and lift herself above the ranks of the neither-poor-nor-rich. Frank Henry admired her spunk, took a grandfatherly interest in her, and gave her counsel when she asked for it.
She was attracted to currency trading, having first learned about it in her bank job. There is a game of high risk but, when you win, commensurately high reward. The basis of he game is the fluid way in which the world’s many currencies fluctuate in value against one another.
To play, you buy – let’s say – a bundle of Japanese yen, paying in dollars. You hope the value of the yen against the dollar will rise. If it does, you happily unload your yen for more dollars than you paid. Because currency values are volatile and because the trading is commonly conducted on a basis of heavy ‘margin’- meaning that you put up only a relatively small amount of your own cash, borrowing the rest from a broker – your leverage is strong. You can double your money, or conversely get your financial teeth kicked in, virtually overnight.
Most small-time currency speculators play with just a few currencies, often only two. This was the young woman’s approach. She felt she had a particularly good understanding of the interplay between the U.S. dollar and the Italian lira. Frank Henry applauded her decision to play just one game at a time – not a bad decision for any beginning speculator – but he got worried when he began to see her falling into the Historian’s Trap.
She told him one day that she had made a thorough historical study of the dollar’s and lira’s ups and downs in relation to each other. Such a study can be useful in any investment situation, as long as you conduct the study without making the underlying assumption that history is going to repeat itself. Unfortunately, the young woman made just that assumption.
According to her studies, she told Frank Henry, the lira always rose against the dollar when the Swiss franc was rising, when American-Soviet relations were cool, and when several other indicators clicked into place in international economics and diplomacy. She proposed to wait until the indicators gave the historical signal, and then she would plunge into the game.
The Zurich Axioms had not been completely formulated when this was happening, so Frank Henry did not have a convenient label like ‘Historian’s Trap’ with which to identify what he felt was wrong with her thinking. He did his best to dissuade her, but she was too excited to listen. This is nearly always the case with discoverers of new moneymaking formulas. “She thought she’d found some kind of magic key”, Frank Henry said sorrowfully. “I asked her why thousands of other brainly people had never found it in years of looking, but she didn’t know and didn’t care. She was so excited that when a young fellow took her out to dinner, at an Italian place one night, she spend half the time talking to the headwaiter about the exchange rates.”
Finally the international indicators said “Go!” and she went. She became the owner of a pile of lira. Which promptly began to lose value against the dollar.
“Sell!” Frank Henry urged when the young woman had lost some 15 percent of her money.
But her illusion of order was too strong. All she had to do was wait, she thought, and her formula would be proved right. The formula had always been right in the past. It couldn’t be wrong now! The market was!
But she was seeing the world upside down. Formula can be wrong, but markets never are. The market does what it does. It makes no predictions and offers no promises. It just is. Arguing with it is like standing in a blizzard and howling that it wasn’t supposed to arrive until tomorrow.
The young woman argued and argues. The international exchange market refused to cooperate. Frank Henry never found out how much money she lost, because he felt it would be unkind to ask. But by the time she sold out her lira position, she had surely been to the cleaner’s.