Tuesday, July 9, 2013

Moods and measurements.

Having our economic destiny driven by manic-depressive markets.

There’s been much talk again recently about what drives what in economics: the immeasurable or the measurable, the way we calculate or the way we behave; the way we think or the way we feel.

It clearly is much more than chicken or egg, and regular readers to The Human Touch will know which side I favour – the title of my column says it all. But then I must concede that I am a product of an age when things were relatively stable, our serenity rattled mostly only by the threat of a nuclear 3rd world war.

Exchange rates were fixed. Even our money supply was disciplined to how much gold we had in our vaults and changing our exchange rate was a huge political event – “devaluation” implying weakness, mismanagement and instability. At the time a 5% devaluation was “groot skande”; a 15% downward adjustment to the dollar a threat to popularity at the polls. No wonder politicians handed the whole sorry affair over to “the markets” where currency values can move by more than that and both ways within weeks, with only obscure blame on domestic management, but mostly on the pretext that “it is not I that am weak, but he that is strong!”

Remember “Decimal Dan, the Rand/cents man”? At that time you could buy a British pound for R2 and $1½ dollars for R1. It was weird. At home you were poor, but when you travelled you felt like a king among paupers – that’s if you could afford the flight, both physically and financially. My first flight to Holland on a Trek Airways DC-4 took nearly a week – I still remember it as being a lot longer, those propellers no doubt having made a permanent contribution to my chronic tinnitus.

Interest rates were even more tightly controlled. You could not change the bond rate without parliament getting involved. As a young bachelor I remember well the scramble for a fairly abundant supply of “rent-controlled” apartments. We had control boards, which occasionally would challenge Economics 101 by putting up prices because there was a product surplus, but somehow always managed to maintain food supplies at affordable prices. Inflation in the happy hippy 60’s was a term mostly only academics used.

It was a time of oppressive economic controls. Paradoxically it was also a time of great self-control and self-discipline. Many of us compiled budgets with our first pay cheques. An intriguing entry I found under “income” in one of my first monthly budgets was: “Found in pocket = R1”. Of course, detractors from this seemingly idyllic picture can rightfully counter that we had a laager economy, a terribly misguided ideology, and were totally out of step with both what was right and with what was happening in the rest of the world.

So before a warped nostalgia takes me to a point where I lose my conviction born in the 70’s that the markets have a certain magic, that they make better decisions than corrupt governments, that they are better informed than a handful of self-serving bureaucrats and that freedom of choice in all our affairs is worth defending to the death, I need to chant my favourite mantra: “perfect markets perfectly reflect all our imperfections.”

There’s been increasing vindication for the view that moods drive markets and that behaviour drives systems, structures, institutions and ultimately our economic destiny. Our “leading indicators” are no longer restricted to scientific data but include many mood measurements such as opinion surveys and confidence indices. At the same time, there’s been growing scepticism about measurements – not only their veracity but whether we are, as Einstein might have asked: “counting what counts; and ignoring what does not count.”

Without doubt the two are linked, but moods affect the interpretation of measurements, even if they are accurate and valid, and in turn influence the markets to achieve an outcome which comes close to self-fulfilling prophecies. Going back to when most will not remember, and when many of us foolishly believed that economics was an exact science, there were really only two groups who one listened to for market forecasts: the fundamentalists and the chartists. The former, especially economists were great at hedging their forecasts with “on the other hand”. Charting was often viewed as a bit of hocus-pocus. Still, their pretty pictures had sufficient following to influence outcomes.

Today we have the quaint distinction between traders and investors – the former being mood merchants and the latter mostly herd followers trying desperately to maintain the courage of their convictions. When they can’t do that and succumb to the traders’ trumpets they become their fodder, caught in the cappuccino froth.

Traders (we used to call them speculators) need bi-polar markets. They thrive on mood-swings: the sharper and shorter the better with the best players making much more money on panic than tortoise moving confidence. And if they can’t peddle that panic, they are not beyond colluding to rig important triggers like LIBOR. Now driven, as opposed to simply using nano-second electronic trades they are ready to pounce on the slightest differential between trading platforms.

Now all of that would be fine, if speculators were not so many and did not have such an inordinate impact on very important prices and rates that affect the real economy and our economic destiny. Consider McKinsey Global Institute estimates that put the “value” of annual financial speculation at $1.2 quadrillion – 15 times more than the $80trn annual value of Gross World Product.

There’s a first for me! I have never written “quadrillion” in an article before!

Most of that trading centres in bank created I.O.U’s we call money, in the process destroying one of the four essential requirements for money: as a store of value. As a stable measurement of value it is on increasingly shaky ground, but is still holding on to its role as a means of exchange. Regarding the fourth, something you can count in (numeraire) … well you could use sea-shells or poker chips for that.

The predominantly naïve part of my character allows me to reconcile these mind boggling developments with one simple thought. Despite the froth, the underlying coffee remains. The sustainable and for me the most solid part of the economy still rests on life enriching, day to day exchanges that provide us with both means and meaning.

Let the dogs bark….the most effective counter to panic is patience.

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