Friday, June 05, 2009

Confidence and con men

Today I've started reading Lords of Finance: The Bankers Who Broke the World by Liaquat Ahamed. This is an economic history of the great Western powers from 1914 to 1931. Its subjects are the bankers who rode out World War I, soared high in the 1920s, and whose very names were just about erased from common histories by the horrible collapse in the Great Depression. Ahamed worked as an economist for the World Bank, then spent twenty-five years as a professional investment manager in London and New York.

In the very first chapter, I was struck by this, written in October 2008:

Nothing brings home the fragility of the banking system or the potency of a financial crisis more vividly than writing about these issues from the eye of the storm. Watching the world's central bankers and finance officials grapping with the current situation -- trying one thing after another to restore confidence, throwing everything they can at the problem, coping daily with unexpected and startling shifts in market sentiment shift -- reinforces the lesson that there is no magic bullet or simple formula for dealing with financial panics. In trying to calm anxious investors and soothe skittish markets, central bankers are called upon to wrestle with some of the most elemental and unpredictable forces of mass psychology.

[My emphasis.] Financiers claim to be peddling arcane knowledge of economic trends based on ever more complex computer modeling -- but perhaps their expertise is just the guesses of persuasive salesmen, a few offering real value and others just snake oil.

This brought to mind James Surowiecki's observations about what is apparently a current Argentine coin crisis. Simply put, there's hardly any small change in Buenos Aires. Why? Because Argentines have been through repeated episodes of inflation, including a hyperinflation when money became almost worthless, and they take rational measures to ward off being wiped out again. People hoard coins because they think the metals in them are more likely to retain value than paper money -- and because they think other people must be hoarding coins.

Surowiecki generalizes about this behavior:

...the Argentine experience actually underscores the degree to which all modern financial systems depend on confidence, and the problems that erupt when that confidence disappears. In the U.S., after all, the chaos of last year both led to and has been exacerbated by a shortage of its own: credit. As people became worried about the health of the system, they took money out of any investment that smacked of risk and put it into cash (bank deposits have soared in the past six months) or government bonds. That, in turn, made others more anxious: less willing to lend and more interested in holding onto their money. Fear bred a credit crunch, which, in turn, bred more fear. And if fear has left the Argentines with too few coins, it has left us, paradoxically, with too much cash (and too little credit). This isn't to say that financial crises are all in our head; certainly our own was sparked by problems that were very real. But there is an irreducible psychological dimension to both crises and recoveries.

This bit of economic reporting seems far too sunny to me. Millions of us -- most of us -- have lost much in savings whether in home values or in securities. Maybe in time some of that wealth can be rebuilt, but, except for the very rich, our futures have been forever altered by the wipe out. Individually we don't have "too much cash," even if the financial system may be paralyzed by fear that is choking off credit.

Ahamed and Surowiecki are not original in pointing to "confidence" as the lubricant that could get the wheels of economic life turning again. Make your day by viewing this Depression era cartoon with the same message. I guarantee you'll smile. [7:42]

H/t Suburban Guerilla.


Darlene said...

Roosevelt said it best, "We have nothing to fear but fear itself."

I rate your post A+.

Kay Dennison said...

Great post!!!! Have you aeen "The Creature of Jekyll Island"? If not, I have a spare copy. E-mail me and I'll send it to you.

Unknown said...

Not to be negative, but here's an interesting update comparing the current great recesssion with the on that began in 1929. Economists Barry Eichengreen and Kevin H. O’Rourke find this one to be worse so far.

All social relations, not just economic ones, require a confidence in the partner: confidence that we can live in peace, that we will look out for each other, and that we have common interests. Successful recovery will be based on trust. Do we have reason to believe that business leaders are trustworthy?