Andrew Haldane, the Bank of England’s executive director of financial stability, has penned a hugely thoughtful piece about the implications of growing cultural impatience and short-termism on financial markets — and society at large.
In a nutshell, Haldane observes that as people’s preferences get more short-termist in mindset, bad money drives out the good– encouraging volatility in stock-markets and the detachment of fundamentals from asset prices.
Another negative implication may also be on GDP. According to Haldane, studies have drawn a more explicit link between a patient society and growth, than an impatient one — meaning the more impatient a society is, the less meaningfully it might grow.
As he notes:
Evidence from social and economic systems points to two evolutionary paths. Along one, patience becomes self-reinforcing. For example, financial liberalisation may encourage patience and improve inter-temporal choice, unlocking growth. But there is a second path, along which impatience is self-reinforcing. Financial liberalisation
can also unlock impatience, generating over-trading and under-investment.These dual equilibria make choosing the right pace and path of financial reform crucial. Some countries, like China, appear to be proceeding along the patient path.
The choice is how to pace reform to prevent overshooting onto the impatient path. For countries which have already liberalised, the choice is how to promote patience while harnessing impatience. These are real public policy choices.
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Studies have linked various cultural and religious characteristics to growth.4 For example, it has been argued that pre-dominantly Protestant countries in Europe grew faster than Catholic countries as a result of differences in patience and work ethic.5 This has echoes with recent literature emphasising the role of “Asian values”, such as thrift and patience, as a driver of growth in the region.6
The implications of becoming more short-termist may hence be very far-reaching, says Haldane — largely because preferences are switching as the distant becomes instant.
Nowhere is this better encapsulated than in the average time that investors are holding stocks nowadays.
Haldane refers to the following chart, which plots the average holding period of investors in the US NYSE index since 1940.
As he notes, it suggests a striking pattern — one that happens to be echoed across markets around the world:
As he explains:
In 1940, the mean duration of US equity holdings by investors was around 7 years. For the next 35 years up until the mid-1970s, this average holding period was little changed. But in the subsequent 35 years average holding periods have fallen secularly. By the time of the stock market crash in 1987, the average duration of US equity holdings had fallen to under 2 years. By the turn of the century, it had fallen below one year. By 2007, it was around 7 months. Impatience is mounting.
He refers to the ‘flash crash’ as a clear example of the fragility such micro-headedness can inspire. Trading in securities, he says, has unintentionally generated insecurities. Or as he puts it:
The impatient world was found, under stress, to be an uncertain and fragile one.
And here are some other observations from Haldane’s paper which we found particularly perceptive on the subject (our emphasis):
Impatience has implications for economic and financial systems every bit as profound as its well-behaved twin. For economies, hyperbolic discounting would tend to generate under-saving, as people seek instant gratification. And neo-classical growth theory says that under-saving has adverse implications for long-run investment and growth. Some jam today would come at the expense of a whole jam-jar tomorrow.
Take happiness. Studies have shown that happy people save more and spend less.15 Happy people also take longer to make decisions and expect a longer life. In short, they are patient. These patterns of behaviour are connected and reinforcing. Expecting a longer life, happy people defer immediate gratification and save. In consequence, they enjoy a more prosperous tomorrow as they harvest the fruits of their investment. In these models, happiness is not just fulfilling; it is self-fulfilling.
Just as patience can self-generate, so too can impatience. And while patience generates self-improving cycles, its alter ego can create self-destructive cycles. Addiction is the classic self-destructive cycle. Drugs and alcohol chemically alter the balance of the double-self, increasing the value of instant gratification. This shortens time horizons, increasing further the value of instant gratification in a downward spiral. Unless arrested, this unfulfilling equilibrium becomes self-fulfilling.
Under one equilibrium, patience wins the day. When long-term investors start in the ascendency, prices tend to correct towards fundamentals. The performance of untested investors pursuing momentum strategies falters, while those pursuing longterm strategies flourish. The fraction of long-term investors rises. The self-correcting tendencies of market prices are thus reinforced, further supporting long-term investors. The patience gene thrives, the impatience gene dies. Natural selection results in a self-improving cycle, as with dieting, happiness and exercise.
But there is a second equilibrium where this cycle operates in reverse gear. With a large fraction of momentum traders, prices deviate persistently from fundamentals. Among untested investors, momentum strategies now flourish while long-term fundamentalists fail. The speculative balance of investors rises, increasing the degree of misalignment in prices. The patience gene falls into terminal decline. Natural selection results in a self-destructive cycle, as with drug, alcohol and food addiction.
Not to mention his thoughts on the consequences of ‘impatience-inspired’ liquidity:
Liquidity is similarly double-edged. It reduces the impact of momentum trading on prices, thereby increasing market efficiency. But it also reduces the costs of pursuing such strategies. In other words, liquidity unlocks the impatience gene. Investors whose judgement is wrong, but whose timing is right, can lock in immediate gains. Liquidity, too, can pollute the gene pool by allowing the impatient to prosper. Like information, liquidity can be too much of a good thing.
So there you have it, the problem may just be too much of a good thing.
And who could have seen that coming?
Related links:
Amusing ourselves to death – Stuart McMillen
High-frequency trading: Up against a bandsaw – FT