I continue my personal search for some glimmer of light at the end of our dark economic tunnel, or at least an answer a question that has been troubling me lately. If it was so obvious in the past years and months that the world economy was heading for disaster, why were economists and business leaders so passive and incapable of turning the ship around? Hundreds of years of compounded economic history, the best minds in the world applied to making the best use of scarce resources; more computer power deployed and more data available in every second of every hour than in the whole history of humanity, and nobody saw it coming?
Well, in all truth some economists did see it coming, but the whistle blowers remained at the margins of the economic mainstream. The whole economic profession has been shown, again, incapable of predicting, even of understanding, the consequences and the complexity of the economy.
And I believe this new book by Shiller and Akerlof shows a fundamental flaw to much of our current economic thinking: by assuming rational economic behavior in the economic agents, economic theory became as elegant in its structure as mistaken in its results. People do not always behave in rational economic ways, sometimes we do, but not always. We are moved by passion, fear, greed, over confidence,
pessimism, and all these feelings are easily transmitted from individuals to society. A real estate bubble emerges right after the dot.com bubble seemed to have taught everyone a lesson. We should know better, but we often don´t.
This book is an absolute MUST READ. I believe it will have profound repercussions in the economic profession, both at the research and applied levels.
As the authors put it bluntly in page 167: "Failing to incorporate animal spirits into the model can blind us to the real sources of trouble".
"...one thing is certain, that at particular times a great deal of stupid people have a great deal of stupid money" W.Bagehot.
"Finance rests on promises, which, by their nature, can be broken"
"...Finance provides a mechanism for shitting resources from those who own them but cannot use them productively to those who can use them but do not own them".
"Finance is a jungle inhabited by wild beasts".
"The vast bulk of banking assets are financed by short-term loans from money markets or liquid deposits, which the banks´ customers think of as equivalent to cash. But a large portion of the banks´ assets are long term () and illiquid. In addition to this inescapable maturity and liquidity risks, banks are also exposed to market, credit, currency and wide economic and political risk. Banks are () perilous. That is why banks typically have impressive premises. "Look", these buildings proclaim, "our institution is as solid as a mountain of stone..." But nothing could be further from the truth."
"...habitual human propensity to swing between an excess of greed and an excess of fear".
"Governments should not provide open-ended guarantees to private risk taking. They should insist on transparency. They should ensure that management and shareholders of failed institutions bear heavy loses".
"The smaller a company´s equity cushion, the greater the incentive to take risks, with less to lose and more to gain".
"Vendor financing: countries with surpluses of exports to sell finance their biggest market" (Translation: China is lending the US. the money to buy its products. For Spain, Germany was lending us the money to buy their Mercedes and BMWs)
"But higher prices of existing assets do not represent greater wealth to society as a whole: the gains of current owners match the losses of would-be purchasers".
"It is hard to imagine any plausible global rebalancing that does not include a substantial reduction in the Chinese surplus".
I have been reading Wolf´s columns and listening to his podcasts for sometime, and I have always liked his reasoning and his capacity to synthesize complex ideas within the constraints of a newspaper article. For this reason I bought and read this book as soon as I could, but my expectations were not fulfilled. He makes interesting remarks but he does not provide what his title claims: I did not find any cure for our financial system. He makes one point very clear: the mess was caused by unprecedented and extreme global imbalances. The richest country, the US, was borrowing from some of the poorest, most ostensibly from China, because the Americans were saving too little, and the Chinese were saving too much.
This is a good book, no doubt, perhaps a bit more modesty on the title would have made it even better.
