Supply Side, Demand Side, or Innovation Side?

Edmund S. Phelps

Newsart for Supply Side, Demand Side, or Innovation Side?

NEW YORK – It has become impossible to deny the so-called secular stagnation gripping the world’s most developed economies: Wealth is piling up, but real wages are barely rising and labor force participation has been on a downward trend. Worse yet, policymakers have no plausible idea about what can be done about it.

 
Behind this stagnation is the slowdown in productivity growth since 1970. The wellspring of such productivity gains – indigenous innovation – has been badly clogged since the late 1960s (mostly in established industries) and was even more so by 2005.
 
Ronald Reagan and Margaret Thatcher viewed the stagnation that was gripping economies by the 1970s from the supply side. They pushed through tax cuts on profits and wages to boost investment and growth, with debatable results.
 
But today, with tax rates much lower, cuts of that size would result in huge increases in fiscal deficits. And with debt levels already high and large deficits ahead, such supply-side measures would be reckless.
 
So now the best and brightest view things from the demand side, using the theory built by John Maynard Keynes in 1936. When “aggregate demand” – the level of real expenditure on final domestic goods that households, businesses, the government, and overseas buyers are willing to make – falls short of output at full employment, output is limited to the demand. And innovation won’t happen.
 
But the demand-siders’ conception of the economy is strange. For them, private investment demand is autonomous, governed by forces that Keynes dubbed “animal spirits.” Consumer demand is essentially autonomous, too, because the so-called induced part is yoked to autonomous investment through the “propensity to consume.” Thus, government measures are the sole way to boost employment and growth when autonomous demand falls short and jobs are lost.
 
This conception grasps neither growth nor recovery. In healthy economies, a contractionary demand shock sets off two types of responses fueling recovery.
 
Adaptations to emerging opportunities are one such response. When firms hit by reduced demand contract operations, the space they give up becomes available for use by entrepreneurs with better ways of running the business – or with better businesses. Some of the employees they let go will start firms (and hire employees) of their own. With every recession, many shops on Main Street disappear; and, over time, new shops – generally more successful – appear.
 
The other response is indigenous innovation – new ideas springing from the brows of various businesspeople. When firms hit by reduced demand stop hiring for a time, some people who would have joined established firms use their situation to dream up new products or methods and organize startups to develop them.
 
The growing number of aspiring innovators toiling in home garages may self-produce some of their capital goods. More important, the accumulation of new startups will gradually generate rising investment demand – induced demand! – and growth, too.
 
Some may doubt this. Can new products and methods fare well in the market if demand is deficient? As an innovator said to me amid the financial crisis, his objective was to take over a market – it mattered little that the targeted market was only 90% of its former size.
 
Can capital be raised where incomes are depressed? Small firms and startups must always struggle for credit, and the Great Recession that followed the 2008 financial crisis made it harder for them. Yet the recession did not prevent droves of such firms from finding financing in Silicon Valley, London, and Berlin. No wonder Germany, the United States, and the United Kingdom are more or less recovered. In the US, total factor productivity growth set records in the 1930s, when the economy fell into and then grew out of the Great Depression.
 
Recovery has fallen woefully short in two kinds of economies. France and Italy are lacking young people who want to be new entrepreneurs or innovators, and those few who do are impeded by entrenched corporations and other vested interests. Greece has no lack of would-be entrepreneurs and innovators, but it lacks a system of angel and venture capital. Some Greeks have formed startups, though not in Greece.
 
The demand-siders say that innovation only makes recovery harder, because it enables firms to meet existing demand with fewer employees. Thus, they call for annual public-sector investment up to the level needed for full employment. But such infrastructure investment would go far beyond what would ever have been undertaken had the economy been left to regain high employment through the workings of adaptive or innovative activity. Indeed, such investment is costly beyond the expense because it preempts the adaptation and innovation that would have brought higher employment and faster growth.
 
Moreover, as long as Western innovation remains narrowly confined, a demand-side commitment to a large, sustained flow of infrastructure investment – and, likewise, a supply-side commitment to a similar flow of private investment – must bring ever-diminishing returns, until, ineluctably, the economy reaches its near-stationary state.
 
Supplying more of the same old goods never “creates its own demand,” as Keynes thought. But supplying new goods can. It is the impediments to adaptation and innovation – not fiscal austerity – causing our stagnation. And only renewed dynamism – not more fiscal irresponsibility – offers any hope of a durable way out.
 
 


Is This the End of the Road?

By: Chris Vermeulen


In May of 2008, there was a very similar stock market 'rally' as compared to todays' 'rally'.

Investors believed that the 'turmoil' during the latter part of 2007 and the early part of 2008 was permanently over and that we were headed towards a strong economic growth!

In actuality, it merely masked the 'declining economic collapse'. The same situation is happening, all over again, even as you are reading this article. There are numerous flashing red lights, currently while the stock markets is 'collapsing' once again, just as it did during the beginning of the spring of 2008!

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There have now been four consecutive quarters in which corporate earnings have declined. The profits from the SPX were down over 7.1 percent during the first quarter of this year.

The U.S. markets have now entered the next phase - a stock market downturn. The global financial system is now starting to 'unravel' which will have far reaching implications!

In fact, the real truth of the matter, is now about to worsen, from this point of time and onwards!

While this country has 100 million American people, who are unemployed and searching for work, and yet are unable to find any, I say this is a major RED WARNING ALERT that must now need be heard loud and clearly!

According to the FED, forty-seven percent of all Americans are not able to come up with $400.00 in case of an actual emergency situation, that they may incur. They would either need to sell personal belongings or borrow the money, somehow!

The majority of Americans are now living from paycheck to paycheck: (http://www.theatlantic.com/magazine/archive/2016/05/my-secret-shame/476415/).

In December of 2015, when the FED raised their interest rates, for the first time, in almost a decade, they had projected a one percent 'hike' in 2016. I was apprehensive of their prediction and had forecasted that the FED would not "materially" hike rates!

The FED later backtracked their estimates to half of a percentage point 'hike', in 2016 during their March meeting.

The chances of a June 2016 'hike' are low to nil as the "Brexit" referendum is being held only one week after that FED meeting. If the U.K. votes for a "Brexit" from the European Union, then the financial implications may wreak havoc on the already fragile global economies.

Hence, the FED will not chance raising it especially before such a significant and important event.

Similarly, post July 2016, the U.S. Presidential race will 'heat up' and the FED will not want to raise interest rates prior to knowing what the next Presidents' 'economic policy' will be.

However, if the world economy falters, the FED will have to follow the other Central Banks and 'restart' QE.

The timing of a stock market 'crash' is presently within our reach. All signs are pointing towards a higher price for gold; both in the near-term and the long-term. Enforced negative interest rates which are more of the FEDs' Quantitative Easing (QE) and the race to devalue the U.S. dollar. This proves to be quite bullish for gold. The timing of all of these concurrent events are affecting the gold market!

The rise of the stock market is widely viewed today as the result of 'Quantitative Easing'(QE).

A bandage was placed on that financial crisis which was never structurally repaired. Today, I believe that investors have long since given up on the FEDs' bond buying as a means of repairing the economy. There is so much skepticism, at this point, as to what direction the equity-market is trending - Up or Down?

  SP500 Weekly Chart
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The response from the FED was to 'debase' the U.S. dollar as reflected in its' decline of 4.7% thus far in 2016. Treasury bond yields have dropped well below 2%. Something has truly gone horribly wrong within the economy! However, the FED is trying to put up a brave front. They have asserted that they are considering a 'hike' in their June 2016 meeting, but this is very misleading as there will be no "material" short-term interest rate hike in my opinión.

  Monthly US Dollar Index:
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  Weekly SP500 Stock IndexS&P500 Weekly Chart
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These problems that exist within all of these markets are that of the global Central Banks, which are sending their mixed messages. They are actually driving the dollar higher for the time being.

Two weeks ago, the Bank of Japan did not provide more monetary accommodation, as was expected, at that time; whereas last week, BOJ announced they would do so. Therefore, the dollar rose up whereas other currencies, including the Euro and the Yen, fell rather hard. This reaction resulted in both metals and stocks going down.

The three Central Banks have now reversed their prior announcements regarding monetary policy, within the last month. First, the ECB and then the FED and now the BOJ.

The FED is currently working on a different scenario in which they are stress testing negative Treasury bills. This scenario, in which the interest rate on the three-month U.S. Treasury bill becomes negative, in the second quarter of 2016 and then declines to -0.5% remaining at that level until the first quarter of 2019.

The Fed stated, "The severely adverse scenario is characterized by a severe global recession, accompanied by a period of heightened corporate financial stress and negative yields for short-term U.S. Treasury securities." (http://www.bloomberg.com/news/articles/2016-02-02/rates-less-than-zero-is-bank-stress-fed-wants-to-test-in-2016).

Gold prices are surging this year and that has 'the smart money' flocking towards the yellow metal.

During this global contraction, it is only a matter of a very short period of time before the stock market reflects this reality.

Truly, this is the beginning of 'The Great Reset'!


Conclusion:

In short, big things have slowly been unfolding that will be not only life changing but will change the entire financial situation of the world.

The good news is that there are many ways to profit and prosper from these events. A few simple and well time positions can yield huge results for the savvy trader and investor.


The appeal of the euro

SELL signals

Joining the euro is still attractive to some

Another blissful day in the euro zone


HAS the euro crisis dissuaded other countries from adopting the single currency? Not a bit of it.

Since 2009, when euro-zone GDP shrank by 5%, four countries—Slovakia, Estonia, Latvia and Lithuania (let’s call them the “SELLs”) have joined. Their experience suggests that the euro still has its benefits, but also some familiar risks.

Many thought that joining the euro would spur the SELLs’ foreign trade, by removing the friction of exchanging currencies. The Slovakian central bank, for example, predicted a boost of 50%. That was wildly over-optimistic: the euro has made little difference to Slovakia’s imports and exports. The problem may have been a confusion of cause and effect. Growing trade between nations is likelier to lead to the formation of a currency union than vice versa.

Baltic firms, meanwhile, have not significantly increased exports to the euro zone, even though the closure of its largest market, Russia, thanks to sanctions in 2014-15, forced many to search for new trading partners. Instead they have exported more to places like the United Arab Emirates and Saudi Arabia.

Happily, a perceived downside of adopting the euro was also overblown. The worry was that shopkeepers would use the changeover as an excuse to put up prices, particularly if doing so got them to a price ending in a “99”. But the changeover in Slovakia seems to have boosted inflation by just 0.3 percentage points. In Estonia large retailers joined a snappily titled campaign, “The € will not increase the price”. (In fact, a prod to inflation would have been no bad thing for the SELLs, which have fallen into deflation in the past year, thanks to cheaper prices for energy and food.)

The euro does seem to have helped the SELLs’ financial stability. Their banks and central banks now have access to emergency funding from the European Central Bank. They are also less vulnerable to turmoil associated with “currency mismatch”. On average, roughly 70% of their private-sector debt was denominated in foreign currency (largely euros) prior to joining.

Any depreciation of their currencies would have made those debts much harder to bear—a risk the adoption of the euro has eliminated.

Rimantas Sadzius, Lithuania’s finance minister, says euro membership also allows his government to borrow more cheaply. Debt-interest payments have indeed fallen. But had Lithuania joined a decade ago, Mr Sadzius would have been even happier. In the early 2000s, according to the IMF, euro membership was associated with a two-notch improvement in the credit ratings handed out by Standard and Poor’s. Since the crisis this premium has shrunk dramatically.

Even as some benefits have dwindled, some drawbacks have got bigger. As a condition of joining, the SELLs are supposed to contribute to the euro zone’s bail-out funds. For the man on the street the thought of rescuing Greece is an unwelcome one: its minimum wage is 70% higher than Slovakia’s and it is richer than the Baltics. In fact, for the most part members of the euro zone do not pay directly for bail-outs; instead, they guarantee loans or provide collateral for them. And the bail-out funds have benefits as well as costs. The SELLs could turn to them too if they ran into trouble.




The big question for the future is whether the SELLs can avoid the mistakes made by other euro-zone countries. In the 2000s low borrowing costs helped inflate a credit bubble in southern Europe.

Happily, the SELLs are not on a borrowing binge, as the Baltics were in the 2000s. Their current accounts are more or less in balance. Private-sector debt has actually fallen since the crisis. Their big banks are now supervised by the ECB. Local management has improved too, says Erik Berglof of the London School of Economics.

Despite this, the SELLs face a familiar problem: declining international competitiveness. Ageing populations and emigration are creating a shortage of skilled workers. The population of the SELLs is expected to decline by 4% by 2030. The result is that wages are rising faster than productivity. In the past year the minimum wage across the SELLs has risen by 9% on average. Joining the club may have contributed, by inducing workers to push for wages more in keeping with the rest of the euro zone, says Robert Juodka of PR1MUS, a Lithuanian law firm.

Governments in the SELLs say they are trying to respond by bringing in structural reforms, such as freeing labour and product markets, to boost productivity and thus maintain competitiveness. With devaluation not an option, such reforms have assumed new importance.

There is still plenty to do.

Much of Lithuania’s labour code is inherited from Soviet times, says Rokas Grajauskas of Danske Bank, which makes hiring and firing difficult. The Slovakian labour market has in recent years become considerably less competitive, according to the World Economic Forum, in part because of misguided tax changes. The euro zone’s newest members may avoid the same problems that befell southern Europeans in the 2000s—but the single-currency club still makes its members pay their dues.

Is The Gold Price Heading To $1,000?

by: Macro Investing
 
 
Summary
 
Citi believes that gold could be heading to $1,000 per troy ounce.
       
While we are undecided on this, we do see limited upside now our two key catalysts to driving gold higher are fading.
       
We have turned our attention to the U.S. dollar and expect a return of up to 9.4 percent this year if certain conditions are met.




We have been long with gold for some time, getting in at $1,150, but we've now decided to close our position in the SPDR Gold Trust ETF (NYSEARCA:GLD) as we're unsure the catalysts which we expected to drive the price even higher will now eventuate. In fact, some market commentators now believe that without these catalysts the price of gold could drop as low as $1,000 per troy ounce.

 

Right now, or at least up until last week, gold was perhaps the number one safe haven for investors. But with the Federal Reserve now looking like it could raise interest rates at its June meeting, the U.S. dollar (NYSEARCA:UUP) looks set to retake its throne as the ultimate safe haven. At the start of May when many believed US rate rises were off the table until next year at the earliest, gold was climbing as high as $1,300 per troy ounce and even had $1,400 in its sights.

We, like many out there, felt this was the start of even greater gains for the precious metal. As the chart above shows, the gold price was not especially high in comparison to where it had been in recent years. But these were years with zero or near zero interest rates. The price of gold looks very different when we expand the chart to show the last 10 years, which include the years before zero interest rate policies.

 

While we think it will take some time for interest rates to rise to ~2%, the mere prospect of it being an eventuality will most likely cause the gold price to trend lower and the U.S. dollar to trend higher. For this reason we believe it is better to go with the herd, if you will, and start topping up positions in the U.S. dollar. Just like the gold price rallied when interest rates dropped, so too will the U.S. dollar when interest rates rise.

The Brexit is looking unlikely.

For a while it was looking like there was a reasonably strong chance that Britain could vote to leave the European Union. But as of May 19, the probability of Britain leaving the European Union decreased according to the Financial Times poll tracker.

 
Sourced from the Financial Times


Although there is still a month to go before the vote, things are looking somewhat settled. While we had always felt that Britain was likely to vote to remain in the European Union, hence why we are long the CurrencyShares British Pound Sterling Trust ETF (NYSEARCA:FXB), we felt it was likely to be a much closer affair in the lead up to the vote.

Due to the global financial turmoil that a Brexit would be likely to cause, we expected a close call with polls would drive the price of gold higher and higher. The reason for this is that its not just markets in the United Kingdom and Europe that are expected to suffer, the G20 have previously warned that a Brexit would pose one of the biggest dangers to the global economy this year. As investors seek safety from these dangers, gold was our preference for a safe haven.

With this looking less and less likely as the days go by, we feel this catalyst is fading.

But will gold drop to $1,000?

Analysts from Citi believe there is a chance that gold will head to $1,000. Gold hasn't been to this level since as far back as 2009, but it is conceivable that it could return eventually. They expect the strengthening U.S. dollar to be the reason, saying:
"We see no reason why gold should not once more trade at $1,050/oz if US$-DXY rises back to the 100-level (now 95.3). Nor do we see anything to prevent gold falling below $1,000/oz if US$-DXY rises above the 100-level."
As the Federal Reserve raise rates we feel it is inevitable for the U.S. dollar index to at least touch on 100 due to the weakness of other currencies. Shown below is the weighting of the index.

 
Sourced from theice.com


Exactly 79 percent of the currencies the U.S. dollar is weighted against in the index have zero or negative interest rates. The remaining 21 percent (GBP and CAD) have rates of 0.5 percent. If this remains the case then the U.S. dollar is likely to dominate these currencies when it raises rates, leaving very little in the way of the index reaching or breaking through 100 in our view.

So, if Citi believes that this will bring the price of gold down to $1,000, then we have to acknowledge it as a real possibility.

Whether it does or not, time will tell. We may have closed our position, but we certainly wouldn't bet against gold and go short with it. The Brexit vote is in 30 days and a lot could change between now and then. As well as this, rate rises in the United States are far from a foregone conclusion. If the next non-farm payroll data release is a big miss, rate rises could be thrown off the table once again.

Moving over to the UUP.

At this stage we are long the U.S. dollar through the UUP ETF. Our medium-term target is $26.00, but we do feel that it could push on $27.00 this year should rates look like they are going to periodically rise.




A rise to $26.00 would mean a return of 5.3 percent, and $27.00 would mean an even better return of 9.4 percent. Should economic data not support rate rises in 2016, then we would expect the UUP to drop down to $23.00-$24.00. So do bear this downside risk in mind. For us the risk/reward ratio is very appealing and we expect success from this trade.

Once again, best of luck with your trades! We'll keep you updated with any changes in our thinking.

Ten Winning and Losing Industries from the Pacific Trade Deal

A 788-page report forecasts which sectors would ultimately gain or lose from the pact over 15 years

By William Mauldin 
.

     The Trans-Pacific Partnership is expected to boost U.S. agriculture and services industries, but would hurt the manufacturing sector, a report found. Photo: Patrick T. Fallon/Bloomberg


The proposed Pacific trade agreement that has generated so much controversy in the 2016 campaign season would likely benefit the U.S. economy overall, but would distinctly help some businesses and types of workers more than others. A nonpartisan U.S. commission released a 788-page report that estimates the extra economic gains or losses that dozens of industries would incur after 15 years under the Trans-Pacific Partnership, or TPP, assuming it wins passage in Congress and is ratified by other nations.

Here are some findings from the report of the U.S. International Trade Commission, with the figures representing the net economic effect of that TPP on that industry over 15 years:

WINNERS

Passenger cars: +$1.6 billion

Lower barriers to car markets in Vietnam and Malaysia–and special measures designed to get American cars on Japanese roads–would boost the car-assembly industry in the U.S., which includes Detroit and foreign producers. But beyond 2032, the U.S. tariffs on foreign cars would also fall, eliminating an advantage in Detroit.

Apparel: +$425 million

The TPP could result in more fast-fashion items, sports uniforms and other specialty items being produced in the U.S., the ITC says.

Dairy production: +$1.8 billion

American dairy farmers would get some new access to big markets in Japan and Canada under the deal, even though the U.S. agreed to accept more milk products from New Zealand.

Retailers and Wholesalers: +$7.4 billion

Lower tariffs on certain types of clothing and other items mean bigger profits at Wal-Mart and other American stores.

Business services: +$11.6 billion

The services sector that dominates the U.S. economy would get the biggest boost from the TPP, and competitive services provided to businesses in the U.S.—think the big accounting firms—would benefit from new overseas business.

LOSERS

Auto parts: -$1.4 billion

The TPP would lower U.S. import tariffs on parts more quickly than on whole cars and also loosen up existing rules from the North American Free Trade agreement that require much of a car to be produced on the continent in order to be shipped duty-free.

Textiles: -$329 million

Vietnam’s presence in the TPP would likely put pressure on less competitive textiles plants, as well as some other manufacturing operations. But specialized and competitive textiles plants could still benefit, and a key industry group supports the deal.

Soybean production: -$407 million

Soybeans and wheat wouldn’t get significant new markets under the deal, and the ITC expects the TPP to raise land prices and take resources away from these products.

Transportation and tourism: -$720 million

The TPP wouldn’t liberalize air travel, and Americans would likely use the extra income from the TPP to travel abroad, which has the effect of giving other countries additional tourism exports to the U.S., the ITC says.

Chemicals and drugs: -$2.9 billion

The TPP’s reduced barriers at the border and complicated trade rules would likely lift U.S. chemical and pharmaceutical imports by $5.3 billion, outpacing gains in exports, the ITC says. The economic hit is small compared with the overall size of the industry.

Ready to Make a Risky Decision? Your Words Suggest Otherwise

Mining digital communications for emotions can lead to better decisions.

Based on the research of Bin Liu, Ramesh Govindan and Brian Uzzi
                      
Words indicate that a trader is in the wrong frame of mind for smart decision-making.

Yevgenia Nayberg
 
Just after lunch on a Friday afternoon, a professional trader sends instant messages to several colleagues about a big tech-stock bet he is about to make. The messages suggest that he is very excited about the trade, but the transaction ultimately results in major losses for his firm.

Could those losses have been avoided if the trader had a better understanding of his own emotional exuberance and how it may be affecting his judgment? And could his instant messages have provided that understanding?

Possibly, according to new research by Brian Uzzi, a professor of management and organizations at the Kellogg School.

Uzzi, along with Bin Liu of Google and Ramesh Govindan of the University of Southern California, wanted to know if people’s electronic communications could offer clues about their emotional state. If so, this could be a powerful tool, as emotions are understood to affect the quality of our decision making.

The researchers analyzed millions of instant messages (IMs) and trades from 30 traders over a two-year period. They observed that the best trading decisions, and highest profits, happened when traders showed a moderate level of emotion in their IMs—that is, not too much, and not too little. Beyond simply improving trades, this finding could help anyone tasked with making risk-related decisions, from air traffic controllers to humanitarian aid groups.
The Rise of Unstructured Data
The study addresses an entirely new way to make informed decisions.

“The architecture, theory, and practice of finance revolve around analysis of quantitative data— expressed in things like balance sheets, income statements, prices, and analyst reports—to help understand where to place investments,” Uzzi says. Financial firms and researchers “have figured out how to squeeze every little bit of insight out of structured numerical data.”

But these days, structured data are not the only game in town. Over the last decade, emails, text messages, and IMs have provided a deluge of available unstructured data.

“The explosion of unstructured data represents the next frontier of information,” Uzzi says. “Because traders are among the many professionals who routinely communicate electronically, we thought it would be of value to analyze the data they generate for insights.”
We Need to Talk—About Risky Decisions
The researchers suspected that IMs could provide a snapshot of traders’ emotional states as they made trading decisions.

“When people set out to do something risky, they actually like to talk to other people before they do it,” Uzzi says. “They chat with others to get a sense of what other people think is risky and incorporate that into their own decision making.”

But most of us take an oblique approach to soliciting such feedback. “People want to appear as good decision makers, and in trading, specifically, there is a need to keep your actual trading secret,” Uzzi says. So, traders fish for information within their social network without being overt about their intentions. For example, when asking what others think, they can reveal their emotional state in their choice of words. “Do they call the market for a stock ‘changeable,’ ‘shifting,’ or ‘volatile?’ Each word reveals a different level of emotional activation, and when many words over many instant messages are combined, you can develop a revealing picture of the trader’s emotional state of mind.”

Thus Uzzi and his coauthors propose that when people talk about risky things, they use language that evokes their emotions, even if only subconsciously. “Most of us tend to be unaware of our own emotional states, unless we’re raging mad or euphoric,” Uzzi says. “So traders may experience a range of emotions that are either beneficial or disadvantageous to their trades without realizing it.”

How might emotions be a boon or hindrance for traders?

Previous research by others has shed some light on how emotions affect decision making. One study compared two groups of people—those who had experienced brain trauma that prevented them from experiencing emotion and those who had not experienced such trauma—on a range of mental tasks.

The study found that while both groups could perform quantitative and other rational calculations, only the non-brain-damaged participants could make risk-related decisions easily. This suggests that people need an emotional response to push them toward one choice or another when risk is involved.
The Just-Right Level of Emotion
Observations of traders at work, as well as lab-based studies, confirm that emotions matter. If traders are “too emotional,” says Uzzi, “they may make poor decisions; if they’re not emotional enough, they may be too slow to make decisions.”

But no one had previously tested whether digital communications could be used to measure people’s emotional state.

To do so, the researchers analyzed all 886,000 trade-related decisions and 1,234,822 IMs from 30 professional day traders over a two-year period. They also tracked each trader’s median daily profit—the best measure of trading performance. IMs were coded for level of emotion, based on the specific words used. For example, “nice,” “gold,” and “hit” were associated with moderate levels of emotion.

The study showed that traders were more likely to use IMs when making trades—meaning they were eager to talk about their risk-related decision—and that the emotion expressed in IMs correlated with profitability. As predicted, traders made the highest-quality decisions at a moderate level of emotional activation.

Excessive emotion is problematic. “If you’re over-activated, your emotional state is drawing cognitive resources away from the analytical brain,” Uzzi says. “You then fail to attend to the right information or your perception of the information becomes distorted.”

But perhaps surprisingly, zero emotion is also not ideal. “We show that unless you reach a certain level of emotionality, you can’t pull the trigger on the trade, and you don’t buy the stock at just the right time,” Uzzi says. The finding goes against conventional wisdom that an emotionless state—the proverbial poker face—is best for decision making in business. As the authors note, even Warren Buffett emphasizes controlling emotion in investing, rather than channeling the right amount of it.
Training a Better Trader
The findings point to valuable practical applications within the red-hot field of financial technology (FinTech).

One possibility is to provide traders with feedback about their current emotional state, to help guide decision making in the face of risk. “Based on their emotional state, they can decide whether to lean into a trade or lean out of it,” Uzzi says.

Traders could also benefit from understanding factors that influence their emotions. “Companies could develop a very sophisticated system that analyzes electronic communication to tell a trader, ‘Every time you talk to Joe, you get overly emotionally activated, and that might drag you toward a bad trade,’” Uzzi says. “Or just the opposite: ‘Every time you talk to Nancy, it seems to sap you of all emotion and you might be too slow on your trades.’ Or that after lunch and on Friday afternoons your emotional activation is not optimal.”

Additionally, traders could use this feedback to train themselves to modulate their emotions, learning how to nudge them toward the optimal state for high-stakes decisions. At the organizational level, a smart system could help identify the employees best suited to the emotional elements of their work.
And the benefit of this sort of analysis extends well beyond traders.

Air-traffic controllers make hundreds of high-stakes decisions daily, and understanding how their emotions influence their judgment could potentially save lives. So do emergency response personnel and those in the military.

“Military and security groups deal with highly emotional decision making,” Uzzi says. “Do I put 100 boots on the ground? A thousand? When do I pull them out? I need to be in the right emotional state to make those decisions.”

Many organizations are already working on smart monitoring systems, Uzzi says. Some are using widely available, unstructured digital data such as Twitter posts to “capture the mood of the masses,” Uzzi says. His research could help optimize such systems. As the authors write, “[T]he tracking of IMs or Tweets during an evacuation or natural disaster could indicate which targets of aid are least likely to make good decisions.”

Finally, these findings could prove useful to entrepreneurs who aim to serve organizations that care about risk-related decision making. Entrepreneurs might tackle whether wearable devices can capture emotional indicators, for instance, or how emotion-related feedback can most effectively be displayed on computer or phone screens.

“There’s lots of blue sky here for creating ventures that take advantage of this science,” Uzzi says.