Stirling Newberry: The Great Martingale Massacre

Imagine there is a good for nothing gambler. He has only two resources: First, he's good for nothing, he's got an unlimited amount of time. Second, he's well born, and has an unlimited amount of credit at no interest. He offers you a chance to play a game, a simple game. It's the flip of a coin. If he loses, then you get what he bet; if he wins, you pay him what he bet, plus a dollar. He can stop any time he wants to, but you always have to accept his bet. Here's the catch: it is with a very loaded coin, and you get to choose which side. You might think that if the coin were loaded enough, the good for nothing gambler would be a fool. He certainly sounds like one.

But the reality of mathematics takes hold. He has an unlimited amount of credit. Each time he loses, he doubles the bet. You can't stop him from placing a new bet, and he has an unlimited amount of time. Eventually, even if the coin is very loaded, he will get back everything and pay back his creditors. Because the payoff is, effectively, one dollar for every time he wins, and the rest doesn't matter. Eventually, no matter how loaded the coin, your money will drizzle into his pocket. This strategy of betting is called a "martingale," and the term has entered into financial theory. The martingale betting strategy doesn't work at the casino, because casinos don't pay off true odds and because even normal runs of bad luck will bankrupt the gambler. The gambler has to have access to astronomical amounts of money to make it work. But rational economic actors, so long as they are convinced there is enough money, will lend to him, because eventually there is risk-free profit to be had.

This is the basic mathematics of George Bush, the double-down President. Each time he fails, he goes back to his backers among the privileged and doubles the bet. Eventually, he will bankrupt anyone with a finite amount of money. And compared to any ordinary player, the government has an infinite amount of money. In fact, the key economic theory of the rational expectations school of economics is exactly that: the government has an infinite amount of money. This idea is embodied in the work of Robert J. Barro, who wrote an influential paper entitled "Are Government Bonds Net Wealth?"

His argument is complex and relies on the mathematics of a concept known as the "rational economic actor." In it, he concludes that under very interesting sets of conditions, if a government runs a deficit, then people will just buy government bonds to pay the expected future tax increases. While this doesn't apply to most governments, or to people, it does apply to the anchor currency in a financial system and to other governments. In effect, the hegemonic power has unlimited credit, so long as they can credibly show to other governments that someday, there will be a shortage of the anchor currency. This is the method that George Bush, the double-down President, is using - going to foreign central banks, and telling them that if they don't back his next throw, they will lose their money and that, anyway, eventually his luck will turn.

Now if you think about this situation, you will start to realize why the very wealthy look and act the way they do. In essence, those who want to be wealthy run around playing this game. The skills they need are (1) the ability to secure credit, (2) the willingness to keep playing no matter how far in the hole they are, and (3) the ability to keep securing people who will play this game with them.

The first requires absolute certainty. The theory of a martingale is absolutely certain, provided you are certain you have unlimited time, and unlimited credit. The second is an iron-clad faith in yourself, the ability to get to the table, smile, flip the coin, knowing that it will probably go against you, but, so long as you keep smiling, it will come out in the end. The third, of course, is the ability to make yourself look stupid, because that is how you find people who are willing to bet all their money to take what looks like a sure thing.

In short, there are going to be people who have complete faith that, in the infinite time horizon, the world will be on their side, people who have absolute assurance - and yet the ability to look disorganized and like a mark, to the public. Look on television, almost every commercial tells you how much you are "saving" by buying a product at 100% over the cost of making it in China.

Time arbitrage is, more or less, the ability to play this game: realizing that, while the short-term cost of a dollar from a particular game is very high, over time it will be less than a dollar. Then there is the bet that one can secure enough credit to keep playing. This is what Long Term Capital Management did; in fact, the mathematics I described was applied to financial theory by many of the people who ran LTCM. And the lesson they learned was that even if the bet didn't work, it didn't matter - they walked away rich and honored, and other people paid the bill. At that point, one would have to be a fool not to try it.

In fact, this situation, in which the privileged can play with the public's money, was described in outline by Berle and Means in the 1930s - and in great detail in the work of John Kenneth Galbraith. "Financial genius," he quipped, "is leverage and a rising market." It is why his biographer, Richard Parker, waxes poetic about the failure of "rational expectations" as a way of bringing general economic prosperity; all it is, is an excuse for the rich to gamble against the poor, with the poor's money.

It would be like finding out that you were playing this game with a gambler, and at the same time loaning him the money. Which, since Bush is playing with the full faith credit of the American public, is exactly what is happening.

Stirling Newberry is an internet business and strategy consultant, with experience in international telecom, consumer marketing, e-commerce and forensic database analysis. He has acted as an advisor to Democratic political campaigns and organizations and is the co-founder, along with Christopher Lydon, Jay Rosen and Matt Stoller, of BopNews, as well as the military affairs editor of The Agonist.

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