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Psychology enters the danger zone

August 24, 2013

Central bank governor

The Financial Times published an article this week titled “Central bank chiefs need to master the art of storytelling”. . At first, I assumed this piece would focus on the rather dominant role of central banks in modern-day economics. However, the author was strongly arguing for the central banks to continue on the path of printing money and obscuring economic facts to make us feel better and confident about reality. After all, QE has worked so far(at the expense of savers) and should continue to do so indefinitely.  A few quotes from the article: “A decade ago, the answer seemed clear: political acumen, excellent economic  knowledge, and the ability to analyse reams of statistics to deliver effective  monetary policy responses. But if Douglas Holmes, a professor of anthropology, is correct, the  Fed chairman needs something else, too: the linguistic and cultural skills of a  preacher-cum-therapist…..Second, when  President Barack Obama picks the next Fed chair – be that Ms Yellen,  Lawrence Summers, former US Treasury secretary, or anyone else – it is no longer  good enough to choose the economic equivalent of a mechanical engineer; nor  “just” a brilliant academic or manager. The next Fed chair also needs to be a  masterful storyteller and cultural analyst, who can read social sentiment, shape  norms, (re) create trust and persuade us all to think in a manner that suits the  Fed’s economic goals, without us even noticing. Somebody, in other words, who can cast spells with both their spreadsheets  and words. In short, what is needed is nothing less than a monetary shaman.”

The reason I bring this article up is the fact that we have now entered a new phase in market psychology that I would describe as the final stages of enthusiasm which border  irrational hope. in 1999-2000, I recall young inexperienced analysts lecturing Warren Buffet on the “new economy” which he (wisely) didn’t “understand”.  In the middle of the last decade, housing became to be the sure thing that could never go down in value and we know how that ended. Today, we have the established press and experts in full belief that central banks have the ultimate power to grow the global economy. Take a step back and think about it. Is it really possible to grow the world economy by merely adjusting interest rates and money supply?

We have to realize that the current phase of irrational thought has become so wide-spread that we are approaching a cyclical top in all asset markets. This does not mean that there will be mayhem tomorrow or even within a year. But it should guide us in understanding the risks created by the majority of market participants using flawed thought process to invest. In the end, reality prevails. I close with a quote by the famous economist Friedrich Hayek who wrote the following in 1933:

“To combat depression by a forced credit  expansion is to attempt to cure the evil by the very means which brought it about; because we are suffering from a misdirection of production, we want to  create further misdirection – a procedure which can only lead to a much more  severe crisis as soon as the credit expansion comes to an end.”  Friedrich  Hayek, 1933


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