Crowds, Markets, Moods and Events
Book Review by John Casti
(Review of the book, The Socionomic Theory of Finance by Robert Prechter, Socionomics Press, Gainesville, GA, 2017)
The Socionomic Theory of Finance (STF) is concerned with the behaviors of crowds and the events that stem from those behaviors. Thus, the focus is on the psychology of crowds, not individuals. As anyone who’s had the misfortune to experience/witness the behavior of a crowd of hooligans at a football match or the actions of demonstrators in the streets of beleaguered urban ghettos, the psychology of masses operates under entirely different rules than those that apply to individuals. In short, the interaction among the individuals making up a crowd gives rise to emergent group behaviors and consequent events that can differ radically from the behaviors displayed by any individual making up the group. In short, interactions matter—a lot!
The two emergent properties of a crowd/population that concern us in this review are what we might term the “social mood” of the population, how it feels about its future on all time scales, and the collective events that arise from, or at least are strongly biased, by this social mood. Let’s look a bit more deeply at both these emergent properties of the group.
Social Mood: For simplicity, we take the mood of a population to be simply the collective feeling/belief the population holds about its future simultaneously on all time scales.
Collective Actions and Events: A social event is one that arises from the collective behavior of the entire population. In other words, it is not the action of a single individual that gives rise to the event, but rather is the outcome of the collective decisions/actions taken by a significant portion of the population as a whole. For instance, the outcome of an election is a social event, while an airplane crash is not.
The importance of time scale comes into play when we recognize that collective events have a natural unfolding time characteristic of the nature of the event. For example, an event involving some aspect of popular culture such as the type of fashions that are in vogue or the sorts of books that are popular at a particular time are short timescale phenomena, generally unfolding over a period of a few months to a year or so. On the other hand, a collective event like the shift in a dominant political ideology has a much longer unfolding time, normally several years to a few decades. Finally, very slowly-unfolding events like the decline of a global power may take a century or more. So if we want to argue that the social mood of a population is a driving factor in the type of event we can expect to see, we must match the timescale of the event with the timescale of the social mood underlying the event. For example, it would give no insight into the likelihood of a country like the USA leaving the world’s center stage to look at the social mood in the USA on a timescale of weeks or even months. That time scale is just much too short to see the unfolding of a long timescale event like the collapse of global political and moral power. Such an event would require examining the shift in social mood on a time scale of decades, not weeks or months.
Our first order of business is to examine the connection, if any, linking the group’s social mood M and the collective events E that arise from interactions among the people making up the group. Logically, there are four collectively exhaustive and mutually exclusive possibilities:
I. M and E are logically independent: In this case, M does not imply E or vice-versa.
The two are totally independent of each other.
II. M and E are mutually dependent: In this situation M implies E and E implies M;
in other words, there is a feedback loop from one to the other and vice-versa.
III. E implies M: Here an event impacts the social mood, but not vice-versa.
IV. M implies E: In this case, the social mood implies the collective social event,
but not vice-versa.
Conventional wisdom argues that hypothesis II is the case, and in fact, this is such a taken-for-granted background belief that it is almost never questioned. The book under review argues that the fact that everyone believes this hypothesis doesn’t necessarily make it true. After all, a few centuries ago everyone believed the Earth was flat too. But that universally-held belief did not make it so. One might call hypothesis IV the Fundamental assumption of Socionomics, a term coined by Prechter to separate this working hypothesis from the closely-sounding label “socioeconomics”, a very different field of investigation.
Notice what’s involved here. The concept of logical implication is an all-or-nothing proposition: Either A implies B or it does not. There is no room for ―sometimes. So either a feedback from E to M exists all the time or it doesn’t exist at all. With this caveat in mind, the conventional hypothesis II says that collective events always impact the social mood, and vice-versa. Hypothesis IV, on the other hand, states that a feedback from events to mood is never present for any collective event.
The work by Prechter and his group at the Socionomics Institute, along with other socionomists provide many cases when such a feedback is, in fact, totally absent. Thus, by Popper’s ―black swan falsification criterion, these
examples serve to invalidate hypothesis II. Here’s another argument that points in the same direction.
The essence of the scientific method is to provide a systematic procedure for testing alternative hypotheses about how to best explain a given set of observations. An essential element in this procedure is Occam’s Razor, which asserts that when faced with several hypotheses that account equally well for a given set of observations, preference should be given to the simplest of the candidates. Oddly enough, the default hypothesis II above, the one almost everyone feels is self-evident, is actually the most complex/complicated of the four candidates, not the simplest! So to accept hypothesis II, it must do a better job of accounting for the observations than any of the other three candidates. And not just do equally well, but do better, in order to be the hypothesis of choice. In STF, the author shows convincingly that the argument that hypothesis IV explains observations and events in the financial realm at least as well as hypothesis II and is much simpler.
As a short aside, it’s interesting to ponder why hypothesis II is so universally accepted. The reviewer’s feeling is that this universal belief in a very dicey proposition stems from a completely unjustified extrapolation from individual beliefs to the beliefs of a group. In other words, if I feel this way and everyone I know feels this way, then the group consisting of me and my friends must necessarily feel that way too. As noted above, this is a totally false generalization. A group can and often does feel and behave completely differently than any of its constituent members, viz., a group of rabid football fans. The root cause of this discrepancy between individual and group behavior is the network of interactions linking members of a group. This network gives rise to the emergent properties of group psychology and behavior, properties that cannot be seen by examining any individual making up the group. STF identifies this difference as social mood vs. individual emotion.
At this point, you might ask: What’s the harm in adopting hypothesis II? Why not take the more complex hypothesis and cover all bases? The answer is that there is no harm in doing that other than you then move the question out of the realm of logical implication into the domain of likelihood and probabilities. In other words, you’re now asking whether the feedback loop is present ―most of the time‖ or some of the time‖ or almost never‖. Without an analysis of the issue from an exhaustive database of examples, it’s difficult to give an unambiguous answer to this question. On the basis of the investigations explored in the book under review, the feedback is always absent.
Socionomics and Finance
Early in his career, Bob Prechter worked as a financial analyst on Wall Street and had the opportunity to see first-hand herding behavior and mass psychology (social mood) in action, and how those beliefs got translated into market movements (actions/events). This experience led to his conviction that it is not events that move markets but beliefs. Thus was the seed sown for what we now call the “theory of socionomics.” Prechter has been developing and sharpening this basic insight into human activity for several decades now, extending it from the financial arena to almost every field of human endeavor. STF is a summary of how social mood drives financial events. Two more volumes of a similar nature are planned, the next book focusing on political events, the third on society and culture.
Over the years, Prechter has formed a strong team of researchers at both his own company, EWI and in other institutions around the world who have explored the fundamental principle of socionomics in just about every human activity from popular culture to wars to the rise and fall of civilizations. As just noted, the current volume restricts attention mostly [Chapter 10 goes into all kinds of social activities] to financial events and how they arise from shifting moods in populations. So in STF Prechter has collected and updated many earlier publications written by himself and jointly with others in his socionomics team on this theme. The book also contains a number of chapters written specifically for this book that have never been previously published. He weaves all this material into a flow that makes it a progressive statement of the theory.
In the space available for this review, it’s simply not possible to comment upon all the gems of socionomic wisdom presented in this 800+-page encyclopedia. So I will content myself with pointing out what I see as a few of the many highlights. As the book is divided into eight Parts, let me just say a few words about each to give a flavor of the contents.
• Part I: The Absence of Exogenous Cause in Financial Markets—this section sets the tone for the rest of the book, first pointing out that the idea of that shocks move the markets is simply a myth, concluding with a by-now-familiar statement in all of economic theory and finance that the time has come for a new model.
• Part II: Socionomic Theory: For the answer to the question, “What is socionomics?” this Part of the book provides a full and complete answer in six installments. The structure of socionomics, various ways to measure social mood, the relationship between social mood and Elliott waves, the connection between observation and prediction and the question of whether socionomics is real science, both testable and falsifiable, are each addressed in sections of twenty pages or so of ultra-readable material. Whether you’re interested in finance at all is really irrelevant here. This Part by itself is worth the price of the book. It constitutes a full course in socionomics in six easy lessons. Who could ask for more? But there is more, much more.
• Part III: The Socionomic Theory of Finance: With the socionomics preliminaries out of the way, here we enter into the world of finance, socionomics-style. Each of the sections of this Part address in their own way the dichotomy between economics and finance. The point is that economics is not finance and vice-versa. So before confronting finance head-on, it’s well worth 70 pages or so to make this fact transparently clear. And that is exactly what Prechter does in this Part.
• Part IV: Herding and Social Mood: The centerpiece of socionomics is the idea of social mood, as we discussed earlier. But how does that mood arise and what forms does it take? These are the themes of this Part of the book. Prechter addresses several myths about crowds here, including the myth of wisdom of crowds along with the myth of exogenous causes for the behavior of financial markets. We spoke in the opening section of this review about causes and events. Now we can see from the sections of this Part that the kind of herding giving rise to social mood is both endogenous and has a universal and fractal structure. In one of the more intriguing sections of the entire book, here we find the account of a study that undermines the idea that crowds can make decisions better than individuals. With these myths undermining conventional wisdoms, the book proceeds to
• Part V: STF vs. Conventional Thinking: The leitmotif of this section is the contrast between the STF and conventional thinking in economics. In each of the sections, the STF is contrasted with some traditional economic “wisdom”: Linear extrapolation, supply and demand, theory of bubbles, the Austrian school of economics, and finally Keynsian and monetarist technocratic theories of economics. Speaking frankly, unless you’re really a dyed-in-the-wool believer in conventional economic thinking, this reviewer feels you can comfortably give this Part a miss on first reading. While it’s interesting from an intellectual point of view, it’s more of a sideshow in the overall message of the book.
• Part VI: The Primacy of Social Mood in Financial-Market Causality: Since social mood plays the central role in all socionomics-based arguments about human events, it’s appropriate that there be a Part in the book that focuses on how the social mood impacts every aspect of financial life. Here we find accounts of how social mood governs everything from the tone of Federal Reserve Board meetings to opinions about inflation and deflation independent of what most people would consider pertinent data. This Part of the book and the following one have been given over by Prechter to a variety of his collaborators and associated researchers. So while the character of the exposition is different in these two Parts, the overall message is equally clear: Mood governs financial events!
• Part VII: Metatheory and STF’s Relationship to Other Theories: With the exception of one chapter, this Part is totally the work of Prechter’s longtime collaborator, the late Wayne Parker. As the sections here show, Parker’s work maintains the high quality pioneered by Prechter as he explores questions of herding behavior, the relationship between the sociology of instinct and rationalization versus the economic ideas of Pareto, and socionomics as a consistent paradigm for the social sciences. The one section here not authored by Parker is a very helpful overview of the literature of social mood by Kenneth Olson.
• Part VIII: And for Dessert . . . : This Part concludes the book with a potpourri of sections ranging from interviews with complexity scientists, an overview of two popular-science magazine articles examining the socionomics hypothesis, and finally an interview with Bob Prechter himself on the origin and future of socionomics.
• Appendix: Key Events in Socionomics: This appendix provides a very useful historical account of 130 landmarks on the path socionomics has taken from its infancy in the 1938 book by R. N. Elliott on the wave principle of financial data to the present work in May 2015.
On the surface, STF looks a lot like a book on finance. But as we know, surface appearances can be deceiving and this is an exemplary example of that principle. This is no more a book on finance than a thermometer is a creator of heat. The true message of the book is that the idea that collective human events cause people to develop a view of their future, a social mood, is a totally and complete myth. STF explodes that myth in page after page of facts, data and philosophy showing that the thesis that events cause mood is as false as the idea that the Earth is flat.
Well, human social behavior is not really about financial markets, either, although they are a good example of where this behavior shows up especially clearly. But as the book shows so eloquently, that social behavior or mood is the driver of events. Anyone who has the slightest interest in how the world really works needs to read this book.