This is the fourth in a series of articles inspired by the Ph.D. research of Patrick Schotanus, titled ‘The Archetypal Market Hypothesis: A Complex Psychology Perspective on the Market’s Mind.’
We have an ambivalent relationship with the sea (I’m Dutch, so I should know). Through human history she offered routes to enriching discoveries as well as ruinous disasters, timely escapes as well as eternal damnation. Metaphorically applied to capital markets the sea invokes the image of investors’ collective dispositions as they discover prices to deal with the uncertainty of exploring the unknown. Generally experienced as ripples, tides and waves, in extremes the resulting moods reach tsunami-like highs and lows.
Like other seminal events which have become part of human history, financial booms and busts reflect myths, the often surreal narratives about heroes, villains and treasure, which capture symbolically the meaning of such experiences. Specifically, market myths accompany those other affective symbols, namely the emotionally charged numbers we call prices. True myths are those that prevail because their meaning strongly echoes from generation to generation and in this sense they make history rhyme. Often myths refer to their ‘false’ cousins. These are the illusions which shatter faith, trust, and confidence. Nowhere is this more apparent than in the case of money itself.
For the past few years I have used the expression: ‘Too much (off-balance sheet) debt, serviced by too little (real) growth, under too politicised conditions (disallowing price discovery)’ to pinpoint the key problem of the Great Recession, at least in developed economies. Similar crises involving the bursting of bubbles fuelled by debt have occurred throughout history. In these cases the subsequent deleveraging in the private sector - particularly by banks - intensified the additional pain of the hangover from exuberance. John Maynard Keynes argued that governments can and should help: public spending, i.e. fiscal policy, can soften the blow of a bursting bubble. From another angle Milton Friedman added that central banks can use monetary policies, in particular by lowering interest rates, to compensate for any insufficient fiscal policies in order to help the economy cope. Fed Chairman Bernanke’s promise to Friedman1 to not ‘do it again’ should be viewed in this perspective. It also highlights the first illusion of money: the independence of central banks.
This brings us to the special conditions surrounding the current crisis. Firstly, governments have accumulated debts over the past few decades to finance their welfare states which embody the principle to borrow from future generations. In my view the current crisis is more about ‘beggar thy children’ than ‘beggar thy neighbour’. The (forced) bail-outs of banks and other financial firms at the height of the credit crunch have exponentially added to their liabilities to the point that their credit-worthiness is being questioned. Overall, the room to manoeuvre in terms of public spending is limited, to put it mildly. Secondly, central banks have lowered interest rates to such an extent that they are approaching or have reached the floor, e.g. the Fed’s zero-interest-rate-policy (ZIRP). Under these conditions countering deleveraging in the private sector by the combined efforts of governments and central banks becomes extremely difficult. Consequently it should come as no surprise why Bernanke used the term ‘fiscal cliff’: he realises he can’t provide a safety net anymore, at least not a conventional one.
The key risk which could tip us into depression is lack of growth. History teaches us that debt overhangs caused by deleveraging suppress growth, which in turn jeopardises the ability to generate the cash-flows required to service existing debts. It is easy to foresee the vicious circle of such a debt-trap. The evil twin of growth is inflation, but this remains subdued as long as the deleveraging occurs in an orderly fashion. Unfortunately, history has also shown that the final phase of deleveraging is often accompanied by a loss of control by the authorities, exemplified by increasingly desperate measures to ‘hold on’. Here we arrive at the second illusion: the value of fiat currencies.
Before the debt crisis is over we will see a number of such measures by central banks, culminating in the printing of money, thereby further debasing their respective currencies. The ECB has already reached panic mode according the Jürgen Stark2, its former chief economist. Bundesbank president Jens Weidmann recently added his criticism to the ECB’s latest policy measure, called OMT, by referring to alchemy and the creation of money by Mephisto in Goethe’s Faust3. Carl Jung was a fan of Goethe and I’m sure he would have loved Weidmann’s speech. Here is Jung’s view on the illusion of money4, spoken during similarly turbulent times:
‘Together with these illusions goes another helpful procedure, the hollowing out of money, which in the near future will make all savings illusory . . . The State takes over responsibility and enslaves every individual for its own ridiculous schemes. All this is done by what one calls inflation, devaluation, and, most recently, “dilution,” . . . Money value is fast becoming a fiction guaranteed by the State. Money becomes paper and everybody convinces everybody else that the little scraps are worth something because the State says so.’
Jung’s critical comment on the role of the state brings us to Friedrich (von) Hayek. Hayek emphasised the complexity of the economy and our limited knowledge about it. The bottom-up interaction of complex minds leads to a top-down complex market. The key in survival for any complex system is the intrinsic ability to endogenously generate innovations, which enables it to adapt to its environment. In terms of minds, mental innovations consist of insights or, as I like to call them, the internal ‘a-ha’ surprises, as responses to external ‘oh-no’ ones. This points to the process of discovery which, crucially, requires respect for the unknown and the freedom to explore.
It is easy to see from the perspective of complex psychology why Hayek was right (and both Keynes and Friedman were wrong). Pretending to know upfront, either as a government (via fiscal policies) and/or a central bank (via monetary policies), disallows exploration, interferes with discovery and instead imposes illusions, the false kind of myth. On the other hand, it is an illusion to believe that Hayek’s ideal will ever materialise. Politicians fear the cleansing of the sea: true price discovery will never be politically correct.
1 Bernanke, Ben; November 8, 2002; “FRB Speech: Remarks by Governor Ben S. Bernanke, At the Conference to Honor Milton Friedman”, University of Chicago, Chicago, Illinois. However, in a 2008 WSJ interview Friedman’s co-author, Anna Schwartz, was highly critical of Bernanke: “I don’t see that they’ve achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job.”
2 Stark, Juergen; September 21, 2012; Interview Die Presse; https://diepresse.com/home/wirtschaft/eurokrise/1293077/Stark_EZB-bewegt-sich-ausserhalb-ihres-Mandats?_vl_backlink=/home/wirtschaft/index.do (downloaded 28/09/2012).
3 Weidmann, Jens; September 18, 2012; “Begrüßungsrede anlässlich des 18. Kolloquiums des Instituts für bankhistorische Forschung (IBF) Papiergeld – Staatsfinanzierung – Inflation. Traf Goethe ein Kernproblem der Geldpolitik?”
4 C.G. Jung; 1936; “Psychology and National Problems”; in CW18, The Symbolic Life: Miscellaneous Writings
