The Bear’s Lair: The costs of consensus

In many areas, such as monetary policy, the U.S. Supreme Court, corporate Boards of Directors and Cabinet government, decisions are made by arriving at a group consensus. If the group is sufficiently intellectually diverse, this works well. There is however a pernicious danger, which we have seen in action many times in economic policy, where an entire group forms a consensus around a generally held elite opinion. In those cases, disaster is likely to ensue.

There is a simple rule for group dynamics, whether it’s the Federal Open Market Committee (FOMC), the Supreme Court or a corporate board. If you have just one vacancy to fill, the safe, experienced option who will not make waves is generally the easiest to select and in many ways the best. However, if you fill all your vacancies that way, the end result will not be pretty. You will get conventional thinking with no dissent. For a court, this will lead to decisions that posterity finds utterly repugnant. For the FOMC this approach will cause huge monetary policy mistakes, either too tight as in 1930-33 or too loose like 1995 to the present day. For a corporation, a Board of Directors full of consensus nominees will completely fail to spot some unexpected market trend and send it bankrupt.

On the Supreme Court, for example, consider a Court of nine Brett Kavanaughs, or if you prefer some mixture of Brett Kavanaughs and Elena Kagans, an equivalently “safe” pick from the left of the spectrum. Routine decisions would be handled very well by such a court, giving the conventional Republican outcome if Kavanaughs dominated or the conventional Democrat outcome if Kagans dominated. But every now and then the Court would come up against a non-routine decision, which required “out of the box” thinking, and in some of those cases, disaster would ensue.

The 1944 decision in Korematsu vs United States, which justified the internment of U.S. citizens of Japanese descent, (and was explicitly repudiated by the Supreme Court earlier this year) was decided by a Court where eight of the nine justices had been appointed by the same President, Franklin Roosevelt. The lone Herbert Hoover appointee, Justice Owen Roberts, dissented. In 1944 Roberts, not in any case a dominant intellectual force on the Court, was unable to assert himself against the predominance of Roosevelt-appointed opinion.

In other areas, the Court of 1944 had three Justices who were certainly not part of a conventional consensus: Hugo Black, Felix Frankfurter and William O. Douglas. Nevertheless, with only one Republican and no strong-willed Republican, it fell into what is now generally regarded as a bad error of consensus. Similarly, the 1857 Supreme Court, that decided Dred Scott v. Sanford by a vote of 7 to 2, another major blot on the Court’s record, was decided by a Court consisting of a large majority of southern and “doughface” Democrats, with only one of the two dissenters, John McLean, being a future anti-slavery Republican.

The most useful justices, therefore, are those who by background or intellectual outlook are extreme or eccentric, therefore taking a different approach to decisions from either political norm. On the Democrat side, Black, Frankfurter and Douglas were all such justices, as to some extent is Stephen Breyer. On the Republican side, Antonin Scalia was such a justice, as is Clarence Thomas, partly because of his unusual combination of conservative Republicanism with an impoverished African-American upbringing. Neil Gorsuch may be such a justice; we will have to see. Brett Kavanaugh almost certainly is not.

On the Fed, Paul Volcker was a highly useful dissident voice as President of the New York Fed, a permanent member of the FOMC, from May 1975, recommending tighter money and higher interest rates to a succession of feckless Fed Chairman and politicians. Finally, he became such a well-known dissident voice that the bond market, battered by repeated bursts of inflation, almost forced President Jimmy Carter to appoint him Fed Chairman in August 1979.

Thereafter, Volcker pursued an entirely new monetary policy, which conquered inflation within three years and set the stage for the economic boom of the 1980s and the declining interest rates thereafter. Volcker’s successor Alan Greenspan was for the first 7 years of his tenure an equally unconventional thinker, having been an acolyte of the gold-standard free marketer Ayn Rand. Regrettably, after many years of courtship, in 1997 he married the utterly conventional liberal TV journalist Andrea Mitchell. As a result, the second half of his term in office, from 1995 to 2006, was notable for the most flaccid Keynesian easy-money policies, which resulted in the excessive stock market bubble of 1998-2000, the housing bubble of 2004-07 and, after his departure, the financial crash of 2008.

Ben Bernanke (2005-13) and Janet Yellen (2013-17) were both conventional easy-money Keynesians, and surrounded themselves with like-minded colleagues, forcing out those like Kevin Warsh (Fed Governor, 2006-11) who showed a tendency to disagree. Consequently, interest rates were jammed at zero for almost a decade, during which the United States suffered a lengthy period of excessive real estate and other unproductive investment, with productivity growth slowing almost to zero. Only a political change, the advent of the Republican President Trump in January 2017, caused the Democrat Yellen to get serious about beginning a gradual rise in interest rates, that has begun to restore productivity growth to the U.S. economy, although it has not yet caused the inevitable real estate and unproductive asset crisis that we can confidently if nervously anticipate.

The question now arises whether the new Fed chairman Jerome Powell, in office since February 2018, is a conventional thinker. He has continued Yellen’s latter-day policy of raising interest rates but has still not got them quite to zero in real terms, since the Federal Funds rate target is currently 2-2¼% while consumer price inflation was 2.3% in the year to September 2018.

Powell is currently being harassed by President Trump, who now doubt is himself being badgered by his former colleagues in the New York real estate industry. This had expanded on the expectation of permanent zero nominal short-term rates and is now turning into a disaster where prices for top-end apartments have dropped some 30% and there are currently very few deals being done. One can hope that Powell is a sufficiently unconventional thinker to resist the blandishments of Trump, and of any squishy Fed governors Trump may appoint, and keep raising interest rates until they are around 2% above the rate of inflation, where they optimally belong.

Only by doing so will the Powell Fed divert resources finally from dodgy real estate and even dodgier leveraged buyout deals and into productive investment where they belong. We have now waited a generation for a sensible monetary policy, with real interest rates securely positive and investment flowing into small business and start-ups, where new jobs and innovation are created. One can only hope that Powell is a sufficiently original thinker and sufficiently secure in his own mind to resist the incredible pressures that will be put on him by President Trump and others and do his job properly.

The same applies in the corporate sector, or in any other area of human activity. For a company to succeed, it needs strong leadership, which must not consist of Identikit managers, diverse in human terms but utterly un-diverse intellectually. Instead it must include eccentrics from unusual backgrounds, who see the company’s business and opportunities from a different perspective to their colleagues. Naturally, a Board of Directors consisting entirely of eccentrics would quarrel, be unable to arrive at a considered strategy, and achieve little. However, even such a sub-optimal Board would be better at identifying new threats and new opportunities than a Board consisting only of like-minded, equivalently-trained drones of diverse backgrounds but brain-numbingly conventional thought processes.

Committees are not an especially effective method of reaching decisions. But in many areas, committees are necessary, to represent all the different interests involved in a decision. Those committees will be deeply inefficient as decision makers, often missing the most important factors involved, if they do not have intellectual diversity. Certainly, diversity of sex, age, ethnic background and childhood circumstances can be helpful. But diversity of intellectual approach is absolutely essential, and intellectual misfits should be actively sought out for all such positions that come open.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)