The Great Mismatch

There exists a great mismatch in society, underpinned by a natural truth. By virtue of of its non-obvious characteristics, this mismatch continues to grow while diminishing the source which gives it life. This mismatch is a contributing cause for the overall stagnation that society at large has experienced over the past several decades.

The natural truth lies in the fact that every individual’s mind has a unique wiring (neural) and make-up (life context). To understand the extent of this uniqueness, it is helpful to explore an extreme case. Synesthesia is an illness where an incorrect neural wiring causes a crossover of sensory perception, such as “seeing sounds”, or “tasting” shapes. It is a common occurrence amongst artists. The concept of this single illness amongst many, demonstrates the physical versatility of the mind, and how modalities of neural wiring & context can enable one to “distort reality”, or at least the commonly held perception of it, and create zero-to-one works. Sean George, Founder & CEO of the genetics company Invitae said in an interview that we have advanced computational abilities to gather vast amounts of data and diagnose diseases, however, the ability to create therapeutics is an art (not science) of finding abstract pathways, and only a handful of “scientists” in the entire pharmaceutical industry have this capability. Considering another case, at its core, most technology (world of bits) companies and their products are merely a set of logical arguments. Whenever a company sells a product, it’s revenue is dependent on making a convincing enough sales argument (aka value proposition) for a customer to buy said product. The sales argument consists of “lines of logic” , which can include price, brand perception, shopping experience etc. The successful business is able to arrange these lines of logic in a coherent and convincing enough manner. When one designs & creates a new product, they undergo the same process of manipulating & arranging logical arguments, but of a different kind. This kind of argument for a product is akin to a legal case, where the defense attorney is the product designer & creator arranging the facts of the case (context), and subsequently turning these facts into a series of coherently arranged logical arguments. The inventor/attorney must coherently arrange lines of product logic (system architecture/design/product emphasis), stakeholder logic (interactions between stakeholder groups) , and “closing-argument” logic (how to convey product & stakeholder logic in a coherent/convincing argument).

Product iteration, the key to product design, is merely re-litigating the case constantly, creating new & more convincing/coherent arguments by manipulating any of the three logics.

The mismatch is essentially the delta of productivity & fulfillment that arises when people choose the wrong professions on the basis of superficial factors and over-determinism, in contrast to ones which they would have the highest leverage, productive output, and fulfillment, if chosen based on mental make-up & wiring. More specifically, the existence of the mismatch is predicated upon individuals not knowing the make-up or wiring of their own minds, understandably so. Rather than trying to address this mismatch by exploring the diversity of undiscovered *natural intelligence, and recasting roles ,society is currently focused on creating a less impressive form of intelligence, of the artificial variety, a true cop-out.

Capital creation through debt plays a fascinating & central role as the source which gives this mismatch life. At its most fundamental level, debt is merely a chance ($) given to another to pursue their own economic activity, that can generate a remunerative return (cost of chance = interest rate). Call it a cost-plus chance. The entire purpose of a productive economy is to translate this chance funded by debt, into equity, through the work of individuals. However, when not enough/low quality equity is created, the economy (or individual business) is stuck in the “chance stage”, a limbo between life and death, transitory equity and debt. Le Chatlier’s Principle, an equilibrium equation that illustrates the flow dynamic of chemical reactions aptly describes this abstraction. In essence, a reaction consists of reactants which when combined, create products. However, if there is an excess of either reactants or product in the chemical reaction, the reaction will move in the opposite direction to reach equilibrium.

A + B ⇌ C + D

(reactants) (products)

⇌ = value accretive activities/productivity/innovation

A + B ⇌ C + D ⇌ E + F

(reactants) (intermediate products) (end product)

(debt) (transitory equity) (terminal equity)

(mismatch slows the rate of the second reaction, solving it is equivalent to adding an enzyme that lowers the activation energy, and speeds up the second reaction (to terminal equity).

One can describe every dollar created as starting its life as debt (left side reactant, source), but then undergoes a series of chemical reactions (productive pursuits ⇌) that aim to generate the end-product of terminal equity. A two-step reaction. This kind of equity’s value is not predicated on, or wholly supported by, cheap debt & financial engineering. Terminal equity’s value is by definition predicated upon discounted future cash flows tied to business’s whose value proposition remains steadfast through market cycles. Transitory equity is a limbo of sorts, an eternal “collateral purgatory”. If capital creation starts with debt, then by definition, incremental $ capital can only be created if the existing collateral underlying existing debt maintains/increases in value. Almost every capital asset can be thought of as collateral, in the context of a debt-based capital creation system. Now, the collateral can increase in value for two reasons. One good, one not. Growth in terminal equity is the good reason. It is fundamentally the “floor” value of collateral which rises in response to growth in *lasting value propositions (high-quality, durable earnings/productivity gains). Transitory equity is by and large, the “hot air” excess in the valuation of collateral (financial assets), fueled by “imbedded growth obligations”. Eventually, when the “hot-air” capital leaves the assets into the consumer sector, inflation is the result. No matter how much capital is created in an economy, if the end stage of the reaction is transitory equity (not terminal equity), “growth” will also be transitory. The goal of every business is inherently to escape the collateral purgatory (transitory equity dependent on incremental low-cost debt).

So, how does the mismatch relate to the source (debt)? Contrary to popular belief, debt in & of itself is not the problem. The problem is that this debt (cost plus chance) is being created & allocated towards incremental pursuits, not paradigm creating/shifting ones (and are therefore propped up by incremental cheap debt). In essence, the source’s ability to grow (debt) is predicated upon transitory’ equity’s value. However, in general, the nature of most business’s created & operated are incremental, not new paradigms, therefore, the source must continue to feed the mismatch, as the mismatch => transitory equity = the vast majority of our capital markets. Unlike the desired two step-reaction shown above, the existence of the mismatch causes a a reaction with a flow dynamic of circularity/reflexivity, instead of equilibrium, as elucidated in Le Chatlier’s Principle.

Stay tuned for part 2: How The Great Mismatch Feeds Into The Financial System