The financial deception chronicles: 2009-2016 edition

Marcus Aurelius said that everything we see is a perspective, not the truth. What we see isn’t always what’s there, it’s warped by our beliefs.

It’s a counter-intuitive concept, but it’s actually been scientifically proven to be true.

A 2013 study by psychiatrists at the CharitĂ© – Universitätsmedizin Berlin, Germany, proved that people with higher degrees of strongly “delusional” beliefs – people who answered yes to such questions as “do you ever feel your partner is unfaithful?” – actually saw the world differently. In this case, they saw dots on a screen literally moving in a way that wasn’t reflected by reality. Their mind-set changed their perception of objectively true facts.

What does that have to do with investing? That’s what I want to explain to you today.

Through the looking glass

When you look at the financial world today, what do you see?

There are a million answers to that question. They all depend on who you are, your perspectives and – crucially – your beliefs.

There is no objective answer.

If you’re in a position of authority in the financial world – at a central bank, government agency or mainstream financial institution – you probably look at the seven years since the financial crisis as a success. Monetary policy has helped save the world economy from a deflationary depression, increased employment and prevented another financial crisis.

But you could also look at the same world and see something completely different. A world where low rates punish savers for their prudence. Where annuity income for pensioners has collapsed. Where financial asset owners benefit, while incomes and economic growth stagnate. And all against a backdrop of skyrocketing national debt.

So I ask you again – what do you see? Perhaps it’s neither of those two perceptions. I’d be interested to know exactly. Get in touch at [email protected].

The point being, of course, that the authorities’ beliefs change how they perceive what’s happening and how they act. That creates problems. It means the world presented to you and what’s really happening, are two different things. It’s a great delusion.

I was reminded of that fact yesterday when reading an early release copy of Tim Price’s new book Through the Looking Glass: a rational guide to irrational financial markets. It’s a great read. If you have that nagging feeling that what’s really happening in the markets and the economy is different to the narrative we’re presented by the authorities… you should read it as a priority. There was one particular section that caught my eye:

The delusion

Economists and financial theorists know what they’re talking about.

The reality

They don’t. But they do offer a superficially persuasive, if necessarily oversimplified, account of the workings of the modern economy. Bundled up within that account is an aggressively overconfident belief in the certainty of economic theory. That overconfidence is what makes economists so dangerous. They have the certainty of exponents of the physical sciences, but the dogmatic self-belief of religious fanatics. Traditional economics is not a science. It has no predictive ability and it does not work.

Modern economics is clearly not any kind of science at all. When the Frenchman Léon Walras, who had serially failed at every job to which he had previously turned his hand, walked with his father one evening in 1858, he was advised by Walras Sr. to have a crack at “the creation of a scientific theory of economics”.

Walras Jr. had previously botched careers in academia, engineering, creative writing, journalism and banking. That he had been rejected, twice, from France’s prestigious Ecole Polytechnique due to poor mathematical skills tells you everything you need to know about the birth of modern economics.

But Walras Jr. did not give up. Rather, he flunked again. Before Walras, economics had not even been a mathematical field. Eric Beinhocker, in The Origin of Wealth, picks up the story: “Walras and his compatriots were convinced that if the equations of differential calculus could capture the motions of planets and atoms in the universe, these same mathematical techniques could also capture the motion of human minds in the economy.”

In other words, Walras hijacked a bunch of principles from the realm of physics and then misapplied them to a grotesquely oversimplified model of his own economy. It’s true: economics was born out of physics envy. The principle of Walrasian equilibrium, for example, posited the theory of a perfectly balanced economy and a fully efficient market. Both of these concepts are now widely discredited. The real world is altogether more complex and chaotic than any model.

If we want to talk about delusions, this is the best of them all: the delusion that economics is a science. Within this delusion the economy becomes a machine to be tinkered with and “fixed” when it “breaks”. It’s not. It’s much closer to a natural system – a natural ecosystem.

And what an ecosystem. It’s the most complex system in the world, driven by the impulses and emotions of more than seven billion people’s actions (or inaction). Virtually every decision you make within this system adds to it: whether to spend that £5 in your pocket on a sandwich or a pint. Whether to save it. Whether to invest it or give it away. Whether to put it to one side to pay your taxes.

Each decision you make – consciously or unconsciously – is important. It depends on who you are and what you want. And taken together with a trillion other decisions it makes up a part of a modern economic system.

There’s no way any can understand all of those choices, never mind control them in a predictable way with policy. Which brings us back to delusion. If you delude yourself that the economy is a machine to be fixed, you’ll try to fix it. In doing so you’ll warp and distort it in ways you cannot possibly understand.

Which is precisely what the authorities have done. This is an idea that Tim talks about in detail in his new book. He cuts through the delusion to the reality. It may not be a pleasant reality to wake up to. But living in the real world and seeing things as they are is preferable to a happy delusion, surely?

Maybe you’re with me. Or perhaps you disagree. Either way, you need to read Tim’s book.

Until then,

Nick O'Connor's Signature

Nick O’Connor
Associate Publisher, Capital & Conflict

Category: Economics

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