Friday, September 2, 2022
Volume 3, Issue 44
Quote of the Week
“Corporations, like people, change their names for one of two reasons: either they’ve gotten married, or they’ve been involved in some fiasco that they hope the public will forget.”
— Peter Lynch, Beating the Street
Rational Inattention Theory
Economics cannot be reduced to mathematical equations because the field deals with human behavior that is difficult to control and predict. This is definitely the case when it comes to the complex feedback loops that influence the level of inflation.
If you are the head of a union and believe that the cost of living for your members will be ten percent higher in a year, your job is to fight tooth and nail to secure a contract that will make union members whole in real terms. If you are a CEO who accepted a union contract with a large increase in pay, you will feel pressure to try to increase the prices charged to your customers. A self-reinforcing feedback loop can develop.
Of course, it is not inevitable that employees will succeed in securing wage increases and the CEO might fail to raise prices. This will depend on the relative power of those who are negotiating. But the pressure and desire to adjust prices will exist as long as people believe that the cost of living will rise substantially in the future.
Given the importance of inflation expectations, it was not surprising to read that Federal Reserve Chairman Jerome Powell brought up this issue during his speech at Jackson Hole on August 26. However, what I found interesting was his reference to a theory I had not heard of before called rational inattention:
“One useful insight into how actual inflation may affect expectations about its future path is based in the concept of ‘rational inattention.’ When inflation is persistently high, households and businesses must pay close attention and incorporate inflation into their economic decisions. When inflation is low and stable, they are freer to focus their attention elsewhere. Former Chairman Alan Greenspan put it this way: ‘For all practical purposes, price stability means that expected changes in the average price level are small enough and gradual enough that they do not materially enter business and household financial decisions.’”
Rational inattention theory makes sense. People are busy and faced with an enormous amount of information on a daily basis. It is usually impossible to weigh each piece of incoming information fully — to attempt to do so would be a recipe for decision paralysis. Instead, economic actors focus on the most important pieces of information.
During periods of rapid price increases, inflation become a focus of attention. But when inflation is low, more decision makers will disregard it entirely, or perhaps de-emphasize inflation relative to other factors that seem more important.
Mr. Powell’s reference to rational inattention theory seems like another way of harnessing money illusion as a policy objective. The Fed is not seeking to create price stability that would allow individuals and businesses to safely stop focusing on inflation. The Fed’s target is to engineer inflation of two percent per year, a level that Mr. Powell apparently believes will be low enough to get people to stop paying attention to inflation even as it continues to slowly erode purchasing power.
The Humphrey–Hawkins Full Employment Act of 1978 established a dual mandate for the Federal Reserve of maintaining price stability while supporting maximum sustained employment. However, Fed economists now believe that targeting true price stability would make it more difficult to stimulate the economy during recessions. This theory is open to debate. But rather than advocating for changes in the law, the Fed has simply decided to change their own mandate.
Given the Fed’s inability to keep inflation under control and the arrogance of officials whose mistakes have led to severe economic pain among those who are most vulnerable, Mr. Powell’s reference to rational inattention theory is quite revealing. The Fed does not intend to fulfill its mandate to achieve price stability. Instead, it intends to simply shrink the inflation tapeworm so that it is less obvious to citizens.
Could the demonised oil industry become a force for decarbonisation? by Schumpeter, August 25, 2022. This article explores the possibility that Warren Buffett might have based part of his investment thesis for Occidental Petroleum on the company’s carbon capture technology. I found this article on the Motley Fool’s Berkshire message board where a number of comments express skepticism regarding carbon capture as a sufficient motivating factor for Berkshire’s involvement. I don’t have much insight into this technology, but I tend to agree with those who believe that it isn’t a major factor in Mr. Buffett’s thinking. (The Economist)
Disney’s New Pricing Magic: More Profit From Fewer Park Visitors by Robbie Whelan and Jacob Passy, August 27, 2022. Disney has an undeniable moat. How else can one explain the money people are willing to spend at Disney theme parks? While customers are perturbed by aggressive pricing, attendance has to be rationed in some way given the high demand. Disney is also considering a new membership program similar to Amazon Prime. Disney holds a special place in the minds of millions of people. This is an amazing quote from one customer: “A lot of people will say, ‘Oh, I can go to Europe for cheaper,’” she said. “But Disney now holds the last really good memories of my dad, so for me it’s so important. I can always make more money.” (WSJ)
Envy Is the Cancer of the Soul by Lawrence Yeo, August 2022. I was reminded of Charlie Munger’s quote on envy when I read this article: “Envy is a really stupid sin because it’s the only one you could never possibly have any fun at. There’s a lot of pain and no fun. Why would you want to get on that trolley?” It’s an amusing quote, but isn’t it true? Envy is toxic. In this illustrated essay, Lawrence Yeo demystifies the nature of envy and, more importantly, provides insight into when envy is likely to strike and how one’s thinking can be reframed when encountering these situations. (More to That)
When Private Equity Takes Over a Nursing Home by Yasmin Rafiei, August 25, 2022. This is the story of a nursing home that was run by Little Sisters of the Poor and sold to a private equity firm. The quality of care soon plummeted in ways that read like a horror story. I often read articles about retirement planning that gloss over or ignore the need to plan for long-term care expenses. Long-term care insurance is expensive, and many older people are skeptical about large cash outlays for a service they may never need. One can keep large amounts set aside for in-home care in one’s final years but that means consuming less earlier in retirement. This article serves as a sobering reminder of what can happen in poorly run institutional settings. (The New Yorker)
The Ultimate Guide to Writing Online by David Perell, August 2022. This is a very long but worthwhile article for anyone who writes in public. There are many reasons for writing in public, but nearly everyone who does so is motivated by the opportunity to communicate a message to readers. Producing good work is not enough given the abundance of information that is available online. Like it or not, writers must learn how to effectively distribute their content if they want their work to be read. Few understand online distribution better than David Perell. (Perell.com)
Why I Moved to Austin—and How It’s Working Out by Ted Gioia, August 28, 2022. Once the media starts to refer to a city as the next big up-and-coming location, chances are that the boom is almost over. However, we have been reading about Austin’s rise for what seems like a very long time. I have never visited the city but find it intriguing. A few months ago, I posted a link to David Perell’s essay, What’s Up with Austin?, which did a good job of listing the pros and cons. Ted Gioia’s article paints a similar picture. In some respects, Austin has definitely arrived. A recent real estate search of newer condominiums in the downtown area reveals prices that are easily on par with many expensive coastal locations. (The Honest Broker)
12 Extraordinary Stoic Moments by Ryan Holiday, August 30, 2022. Twelve short vignettes of how several well-known individuals including Jackie Robinson, George Marshall, Theodore Roosevelt, and James Stockdale embraced stoicism through their actions. “Unlike the “pen-and-ink philosophers,” as the type was derisively known even 2,000 years ago, to the Stoics, Stoicism is something you DO. They were most concerned with how one lived. The choices you made, the causes you served, the principles you adhered to in the face of adversity. They cared about what you did, not what you said.” (RyanHoliday.net)
On Tea and the Art of Doing Nothing by Thomas J Bevan, August 27, 2022. It is almost impossible in our constantly connected world to take the time to do … nothing. Even disconnecting from technology is very difficult. So I found this article on the art of doing nothing at all quite interesting. My personal goal is to be disconnected from all electronics every Sunday. I fail to achieve this goal more often than not. I am not usually a tea drinker but perhaps I should give it a try. (The Commonplace)
Rational Reflections is a reader supported publication. Weekly Digest is free for all readers. To receive additional content, including in-depth business profiles, please consider signing up for a paid subscription.
This is a partial list of recent articles available exclusively for paid subscribers:
Burlington Northern Santa Fe, August 25, 2022
CarMax: A Disrupter Faces Disruption, August 16, 2022
Berkshire’s Ownership of Occidental Exceeds 20%, August 11, 2022
Berkshire Hathaway’s Q2 2022 Results, August 8, 2022
Buffett’s Bet on Occidental Petroleum, July 21, 2022
Tractor Supply Company, July 13, 2022
Investors Title Company, June 30, 2022
America’s Car-Mart, June 8, 2022
DaVita: An Essential Provider of Dialysis Services, May 20, 2022
David Senra – Passion & Pain, August 30, 2022. 1 hour, 23 minutes. “David Senra is the creator of the Founders podcast. We cover what made him obsessive about studying history’s greatest entrepreneurs, the most common themes he’s discovered in his studies, and the role obsession plays… In this conversation, we cover many of the most common themes he’s discovered studying hundreds of entrepreneurs like Estee Lauder, John Rockefeller, Enzo Ferrari, and Edwin Land.” (Invest Like the Best)
Becoming Steve Jobs: The Evolution of a Reckless Upstart into a Visionary Leader, August 30, 2022. 1 hour, 39 minutes. If you admire Steve Jobs or simply want to learn from his remarkable life, this podcast is a must-listen. The Founders podcast is a series of episodes based on biographies of entrepreneurs. There are 265 episodes available. I did not know about this podcast until I listened to the Invest Like the Best interview of David Senra, listed above. There are a number of episodes in the catalog that I have queued up. (Founders)
Men’s Wearhouse: George Zimmer, August 29, 2022. “You’re going to like the way you look! I guarantee it!” “In 1970, George Zimmer was a college graduate with no real job prospects and little direction. That’s when his father, an executive at a boy’s clothing company, asked him to go on an important business trip to Asia. It was that trip that propelled him into the world of men’s apparel. In 1973, the first Men’s Wearhouse opened in Houston with little fanfare, but by the mid-80s, George Zimmer managed to carve out a distinct niche in the market—a place where men could buy a good quality suit, at “everyday low prices,” along with all the shirts, ties, socks, and shoes they need.” (How I Built This)
Tweets of the Week
I am experimenting with threads on Twitter. I prefer to write articles vs. twitter threads but I am trying to grow my Twitter following which, in turn, should result in more Rational Reflections subscribers.
This is a thread on how to skim a 10-K report. Several years ago, I wrote an article covering the same topic:
I also posted a thread linking to book reviews I have written on Warren Buffett and Berkshire Hathaway over the years.
Finally, I wrote a thread on Warren Buffett’s unusual attributes and how they combine to make him an outstanding investor:
Photo of the Week
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