Reversion to the Mean, why the post WWII age of prosperity isn’t coming to an end

Investors often speak of a concept called “reversion to the mean”. Simply stated it is the theory that says prices, investment returns and physical systems eventually return to their long run average. Mathematicians and physicists can go on and on as to why it’s true and how it works. While most of us understand this as a simple concept and acknowledge its validity, we often fail to apply it when forming our views of the future.

There is a natural tendency to see current trends as going on somehow forever. If this were true we all would have starved in a famine, died in a war, the oceans would have boiled away, or frozen solid. We are here because systems are self-correcting.

We collectively saw housing prices as always rising. A popular justification at the time is the idea that there is a finite amount of land and populations will always increase. Maybe, but not at the pace we were experiencing before the housing crash. According to Robert Shiller citing 400 years of housing price data, it is arguable whether this is even true.

We know prices going up forever isn’t possible yet it’s a difficult concept to shake.

People have an innate belief in the Second Law of Thermo Dynamics, which loosely states, things always get worse. The law is valid but it only applies to a closed system where external inputs are not permitted. It works when we set something in a glass-sealed vessel and not let light or heat get inside. A nice experiment but not something that can explain the world. Yet, when we look at the trend of something we have this law in mind even thought we are only looking at one dimension of a system. External inputs always intrude to bring things back into line. Sometimes we are that external force. Houses fall apart over time and left to their own devices will. But, we paint the house and mow the lawn. Not to put too fine a point on it, the second law is not a guide for living.

Still, we see downward, or upward trends as taking on a life of their own. We see global warming,; we all die and the oceans boil away like Venus. We see oil supplies running out; we will all freeze to death, in the dark. We see Communism; it takes over the world. We see gridlock in Washington; we see the end of democratic civilization.

There is a commonly held belief that politics somehow used to be a gentile sport, often romanticizing the Lincoln – Douglass debates. The real story is in times of stress politics become polarized with nasty exchanges, backstabbing and subterfuge. And then when times are good political differences narrow and polite discourse returns. Deals get done. The 1980’s were like that.

Looking at the current polarized political climate, our economy is struggling, the middle class is shrinking and troubles in the Middle East seem unresolvable. Given this, people have very different ideas on what policies will bring prosperity and security. Some feel the Government should spend a lot more money to invest in our future. Others feel we have already over committed Government resources and have mortgaged our future to our children who won’t be able to pay off our debt. So spend more or spend less, not so easy to compromise on.

I submit the gridlock in Washington is due to a difference in opinion rather than an unstoppable decline of civilization. Given the genuine diversity of opinion of what to do, no wonder there is gridlock in Congress and between Congress and our President. I hate to say it but I feel they are behaving rationally.

As far as the vitriol and rudeness being exhibited by our elected leaders today, it’s also cyclical. In good times people are polite as their differences are small. When times get tough views can differ widely. Those of us who are old enough can remember a more cooperative time in Washington when legislation was bipartisan and members of Congress were polite. Those times will return. I just don’t know how or when, but they will.

At the time of our nations founding there were considerable arguments, often heated or underhanded. The idea of what this new nation would look like was unclear and there were genuine different points of view. Ultimately it was the concept of equality and joint destiny put fourth by the Iroquois Indians that contributed strongly to the ideals.

President John Adams suggested that all (of Alexander) Hamilton’s overheated ambitions and impulses might be attributed to “a super-abundance of secretions which he could not find whores enough to draw off!”. He also called his own Vice President Thomas Jefferson "a mean-spirited, low-lived fellow, the son of a half-breed Indian squaw, sired by a Virginia mulatto father." James Callender, a writer secretly funded by Thomas Jefferson wrote that John Adams was a rageful, lying, warmongering fellow; a “repulsive pedant” and “gross hypocrite” who “behaved neither like a man nor like a woman but instead possessed a hideous hermaphroditical character.”

Polite politics will return. The Chinese will not eat our lunch in the same way the Japanese failed to. The middle class will grow again as skills match opportunities. The world will become safer as it has year after year for a century, despite what the headlines say. I don’t know how, just call it faith in reversion to the mean.