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"Perception is a mirror, not a fact. And what I look on is my state of mind, reflected outward."

— Ralph Waldo Emerson

Perception is reality, especially in finance

The human brain is a pattern-matching machine.

It has to be because the sheer volume of sensory input would otherwise drown us in noise and leave us cognitively incapacitated.

Our retinas are bombarded by a chaos of photons, but we see pictures; our cochleas are assaulted by a cacophony of vibrations, but we hear music.

It’s only by distilling the noise into recognizable patterns, filling gaps in the data with best guesses, and making predictions based on experience that we can make sense of the world around us. 

We often overdo it — overfitting the data makes us see faces on a piece of toast, clouds in the shape of animals and conspiracies in the random course of events.

But recognizing patterns — illusory ones, included — has been an evolutionary advantage for us.

We evolved to view the world not as it is, but in a way that is useful to us, as the neuroscientist Beau Lotto explains: "We can never see [the world] as it is. In fact it’s even useful to not see it as it is."

Mistaking a vine for a poisonous snake, for example, keeps us safe from stepping on a real one.

In short, the brain doesn't just passively reflect the world around us — it actively constructs a world for us to see by matching inputs to our expectations.

Investor brains do this perhaps most of all.

We are so desperate for markets to make sense that we convince ourselves that stocks move in recognizable Fibonacci patterns and that straight lines drawn on a graph can be "support" for a falling stock or "resistance" for a rising one.

Sometimes these patterns are so widely observed that they become a self-fulfilling reality — although generally not for long: Technical analysis is much more astrology than astronomy.

A slightly more sophisticated version of this financial astrology is "correlation."

Traders are always looking for correlations to trade, especially in times of market turmoil — when markets get noisy, we look even harder for patterns that might help us make sense of it.

Markets have been unusually noisy over the last week, so investors have been unusually busy looking for patterns — in bitcoin especially.

The day after Liberation Day, for example, Bloomberg detailed bitcoin’s changing correlations and opined that this is "proving Bitcoin is more leveraged beta than digital gold."

"The gravitational pull of the stock market on Bitcoin is getting stronger," Bloomberg’s McGlone noted, "while gold’s negative correlation to US equities is increasing."

(Bitcoin and the Nasdaq 100 are both down about 17% this year, while gold is up 12%.) 

Duke University’s Lee Reiners looked at Bloomberg’s data and took the conclusion a step further: "We can finally put a nail in this digital gold thesis." 

But writing just a few days later, David Lawant reached the opposite conclusion: "BTC’s beta to broader risk assets appears meaningfully lower in this selloff than in previous ones," he wrote for Falcon X. "This points to a growing recognition of BTC’s potential role as a non-sovereign store of value during periods of economic stress."

I suspect Lawant has the right of it —  bitcoin is not yet a safe haven for investors, "but the behavior is starting to echo one."

But these are just correlations and correlations are fluid.

Bitcoin, for example, was thought to be a hedge against inflation up until 2022 when there was a lot of inflation and bitcoin was inversely correlated to it.

Now, we think bitcoin is probably only a hedge against hyperinflation (a conveniently unfalsifiable thesis).

Something similar might be happening this week.

Investors have recognized that bitcoin is not a hedge against a stock market crash (especially on weekends when it’s the only available source of liquidity for investors to panic out of) — but they might be starting to treat it as a hedge against something much bigger.

Bitcoin’s claim to be a dollar alternative has been pure narrative — it's gone up many multiples since 2009 despite the dollar only getting stronger.

But the perception has nonetheless grown that bitcoin is a hedge against a true dollar disaster.

Worryingly, we might soon find out if this perception has become reality.

In the wake of Trump’s tariffs, Adam Tooze, a historian who has never been a dollar-doomer, asked, "What if investors, both American and foreign, decide that they no longer wish to hitch their wagon to the empire of the mad king?"

Specifically, what if a foreign head of state or central banker loses the perception that "holding billions in dollars newly created by the Fed" offers the security they need.

If so, "you sell the dollars [because] you just want out of the mad house."

There are some early signs that important people might soon want out of the mad house.

Singapore’s prime minister noted yesterday that the "US [is] rejecting the system it created; Germany is said to be considering pulling gold out of [the] US because they fear it may not be safe there; and Canada’s Mark Carney responded to Liberation Day by acknowledging that "the global economy is fundamentally different today than it was yesterday." 

Tooze still believes the dollar will probably survive, mostly because of historical correlations: "In 2020 and 2008, even as major pillars of the US financial system wobbled, there was no general rush out of dollars. People wanted liquidity IN DOLLARS."

But this positive correlation between financial fear and demand for dollars is based at least partly on the perception that US Treasurys are a safe haven asset — and that is not a fundamental fact of the universe.

If investors’ perception of the US changes, it will be another case of our brains doing what they’ve always done — reshaping the world to fit the patterns we expect to see, useful or not. 

But when enough people share the same illusion, it stops being a pattern and starts becoming a market.

Bitcoin’s fluctuating correlations might be an early sign that’s happening.

— Byron Gilliam

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