Smart People, Red Balls, Uncertainty and The Most Dangerous Man in America (and Why Stock Market Forecasts Are Nonsense)

Daniel Ellsberg, an economist in the mid-20th century, posed this problem:

Suppose there are two boxes: box A holds 50 red and 50 black balls; box B also contains a total of one hundred red and black balls, but in a ratio which is unknown.  A ball is to be drawn at random from one box, but you can choose the box.  You win $100 if the ball is red.

Which box do you choose?

If you are like me and like most other normal people (which is a insidious way to pay myself a compliment), you are going to say, "Of course, I will choose box A.  Because it's predictable (and because I am human)."

Lemme complicate it for you.  Ellsberg now asks you this:

Now suppose you win $100 if the ball drawn is black, but the boxes are left unchanged; will you change your choice of box?

Assuming that you are (still) normal, here's what I think you are thinking: "Well, nothing really has changed.  So, why should I change my choice?  I will stick to box A."  Unless, of course, you cannot make up your mind and choose to flip a coin and it shows up box B (in which case, stop reading this blog immediately and meditate till you are hungry).  

Do you know that this problem (the balls problem, not meditation, which isn't that big a problem) is called the Ellsberg Paradox?  That is an unusual label: it just does not make sense to call it a paradox because there is nothing paradoxical about it.  Which, in good turn, brings me to a sub-species of humans that I abhor above all others: homo economicus.  Economists, those greasy Orthodox types 

who go around saying Humans Are Rational Decision Makers, despite all evidence pointing in the opposite direction.  

It's they who called it a paradox, because they could not understand why humans (normal ones, Homo sapiens normalicus) did not change their option.  

According to these Orthodox Economists with their focal length (and cerebellum) detached from reality, if someone chose box A first, then she did so with good reason; her  belief is that it contains more red balls than box B - in other words, in her view, the probability of a red ball being drawn is higher.  That view, they said, is, for her, a fact, something she believes to be true, else why should a Rational Human choose A over B?  

Do you see how silly this is?

Therefore, these economists continued, in the follow-up question, she should change her choice of box, in the belief that box B will have more black balls.  

This is entirely segregated from common sense, isn't it?  One school of economists - again,the Orthodox types (bet you did not guess that) - believe that, even when we have no basis to do so, we should always think in terms of probabilities (even if we have to invent them. I am serious!).  The net result of decades of such thinking and academic acknowledgement of such thought is that we take decisions assigning probabilities to future events about which we know, well, zilch.  

I am always astonished at how the extraordinarily bright people I know spend most of their time doing useless things like forecasting stock prices or market movements or 2023 annual sales or economic growth, and then pretend that these numbers are sacrosanct, when not one of these bright, enthu cutlets can even forecast if their domestic help will take a day off tomorrow.  

Sometimes, if there are enough people to conjure up numbers that seem to be alike, it becomes - for a while - a self-fulfilling prophecy (example: the private equity investment insanity of the last few years).  It's only, Warren Buffett once said, when the tide goes out that you discover who's been swimming naked.

Lesson: Measure what you can.  For everything else, there's Mastercard.

(this is an aside.  I tend to connect random things).

Back to Daniel Ellsberg.  He was once called The Most Dangerous Man in America by Henry Kissinger, which is a museum Exhibit A for a pot calling the kettle black.  

If you want to know why, here it is

https://theconversation.com/how-richard-nixons-obsession-with-daniel-ellsberg-and-the-pentagon-papers-sowed-the-seeds-for-the-presidents-downfall-159113

And, finally (I promise), if you want to know why ol' Henry Kissinger was (and is) the most dangerous man in America, just check online and read till the tomatoes that you'd like to throw at him rot - there's heaps of stuff (to read, not tomatoes).

More later (blogs, not tomatoes. Can you stop your food obsession please?)