Wednesday, October 18, 2017 / Perth Australia / By Niekie Jooste
In this edition of "The WelderDestiny Compass":
Economics seems to be very complicated. After all, even the top financial dogs like Fed Chief Ben Bernanke got it wrong when he did not see the USA sub-prime mortgage debacle unfolding before his very eyes. Not to mention just about every central banker that has held the position for any length of time.
Central banks (and commercial banks) have thousands of PhD level economists working for them, designing models to predict how different financial policies will impact an economy. So, we conclude that economics is clearly very complicated.
We then end up with a tulip mania bubble, (1637 collapse) a Mississippi bubble, (1720 collapse) a Japanese property bubble, (1992 collapse) a dot com bubble, (2001 collapse) a USA property bubble, (2007 collapse) just to name a few of the economic disasters.
Currently we have a big speculative rush into cryptocurrencies. Time will tell if we are currently in a speculative bubble, or merely at the start of something much bigger.
Today we look at how human nature lies at the foundation of much of what we have seen happen in economics. Knowing how human nature affects economics does not make it easier or more predictable. In fact, it helps us understand why economics is rather unpredictable, and why economic models based on theories that ignore this important factor is destined to give very poor predictive results.
Today we tentatively dip our toes into this interesting world of economic psychology, and come to a rather useful, if somewhat disconcerting conclusion.
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Now let's get stuck into this week’s topics...
In the good old days, central bankers were rather grey and uninteresting characters. Nobody worried about them too much. Much of that changed during the "reign" of Fed chairman Allan Greenspan. As Fed chairman, Allan Greenspan started using a technique called "forward guidance".
In essence, forward guidance is when there is verbal guidance given on what could potentially happen to monetary policy in the future, without actually changing any of the policies in the present. Markets will then react to the "intention" of the monetary authorities. Often this would result in no action even being necessary by the authorities.
Another way of saying this is that the financial authorities "talk the market" into the direction they want it to go, so that they do not actually need to take much "real" action.
This shows us that instinctively people know that economics is based on human nature, and not necessarily some immutable economic laws constructed by clever economists. If that was not the case, financial authorities would direct the economy by pulling levers and turning knobs behind the scenes where nobody was watching.
Another clear example of psychology in economics is how hyper inflation manifests.
The "short explanation" for inflation is that too much money is chasing too few "products" or resources. Normally we associate inflation with money printing by the governments of this world. While this is true to an extent, if this was the only driver, then most of the world would be subjected to extremely high rates of inflation at the moment.
As a remedy to the 1992 Japanese property bubble collapse, the Japanese government went on a spending spree to pump as much money into the Japanese economy as possible. This has only accelerated in the last few years under the "Abenomics" program of Shinzo Abe, the Japanese prime minister. In all these years, despite all the money printing, Japan has been struggling to get out of a deflationary scenario, never mind inflationary scenario.
In addition, since the global financial crisis of 2007/2008, most major economies such as the USA, Europe and China have been running big budget deficits to try to stoke inflation, but consumer inflation has been stubbornly low.
Clearly there is more to this than just money printing by the government.
In fact, what is much more important is not how much money there is, but the velocity of the money in the economy, and particularly what that money is being spent on.
Hyper inflation occurs when people no longer want to hold onto money, but rather want to exchange it for goods as speedily as possible. Then the velocity of money increases greatly. Suddenly there is a lot of money chasing the available goods.
Why would people want to spend their money as fast as possible? When they get scared of course! When they are scared that their money will be worth much less in the future than now, they want to get rid of it as soon as possible.
In short, hyper inflation results only when people start to loose confidence in the money. It is down to human psychology. Money is worth less, because people believe it is worth less.
The important take-away from todays discussion must surely be how this psychology manifests itself within each one of us. If we can get a grasp of our own emotional responses to money, then surely this will help us to better create wealth for ourselves.
Studies have shown that people that have a poor relationship with wealth, have a very big probability of being less wealthy. If we believe that somehow being wealthy is immoral, then our own wealth building decisions will be very poor. If we constantly live in a mental world of "scarcity", then we will not be prepared to invest our resources into building our own capacity for greater wealth creation.
Most of us just live from month to month, paying debts and squirreling away as much as possible for our retirement in superannuation accounts, or 401k's, or whatever the leading retirement savings vehicle is in your part of the world. Because we are constantly living with a scarcity mentality, we end up abdicating responsibility for our own wealth generation, and giving away the control of our own money to big institutions that get rich by "skimming the cream" from our money.
If we can get our head into a wealth generation mindset, where we take responsibility for our own wealth building efforts, and ensure that we teach ourselves the skills necessary for wealth building, then we will not only end up with much better outcomes, but we will also enjoy life a whole lot more.
In an ever-changing world, relying on "old-school" financial institutions to look after our wealth will probably not work out so well in the end!
Yours in welding
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