THE ROLE OF BELIEF IN THE ECONOMY

The guarantee of the credibility of the currency they created gave governments a huge advantage: they could always create what everyone would do anything to achieve.

“Finance is theatre. Both require the collective voluntary suspension of disbelief. When we buy stocks, or even so much as make a bank deposit, we implicate ourselves in the illusion that a few slips of paper, a few drops of ink or a few lines of code are interchangeable with bushels of wheat, parcels of land and weeks of labour. Pretending that the Prince of Denmark speaks in English verse, or that French police inspectors sing harmony, is a petty achievement of collective imagination compared with currencies and securities.

At the theatre, in exchange for our suspension of disbelief, we expect a concerted effort to produce verisimilitude. The narrative we preemptively consent to must be absorbing and at least minimally plausible. Efforts must be made to disguise the cables protruding from Spider-Man’s costume. Comanche warriors shouldn’t be played by dudes from Appalachia. The demand for verisimilitude is what makes theatre risky. The audience reserves the right to stop pretending whenever they feel their feats of imagination are not being earned. They could decide at any moment that jeering the actors or hurling rotten tomatoes is superior entertainment. No matter how tight the script, no matter how well-rehearsed the cast or expensive the production, there is still always a chance that it all goes terribly wrong.”

Matt Seybold, lecturer in American Literature and Mark Twain Studies at Elmira College, makes interesting comparisons between economics and literature (and drama in particular) in his essay [1]. Readers, do not be so hasty to fall into the authoritative fallacy, doubting what a scholar of literature could know about the economy, since this idea has in fact been stated by prominent economists in the past, as well as their 21st-century colleagues.

1. Is a free market economy logical and rational?

Alan Greenspan, the 13th President of the United States Federal Reserve said, “The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default” [2]. What he said makes perfect sense, because based on a consensus view in macroeconomics, we cannot accuse a government of default on debts denominated in its own currency, as it can always print more money to pay off debt.

If you compare the play with the economy, then money is one thing to convince the inhabitants of this planet to continue to pretend to participate in large-scale roleplaying. The utility of money, from its store of value to its measure or means of payment, is so compelling that the inhabitants of this planet are willing to work hard all day in exchange for it. Of course we can’t call this an illusion, the same way a madman is tricked into hoeing the land for dry leaves, because paper money, a virtual number in a bank account, or bitcoins, can actually be exchanged for a hearty meal, a trip, a house, or anything else that money can buy. But these guarantees do not change the fact that money has no intrinsic value at all. Humanity agrees to complete the assigned task, the person who prepares a hearty meal for you also in the hope that the money earned from the effort will be used to meet other needs of their own — to which people also are willing to respond for money… it is these activities that create intrinsic value. So we need people to keep the operations going, not money; But money can help establish a multi-purpose network that drives people to stay active.

While everyone’s jobs still revolve around those green papers, the belief in money has given its advantage to those who produce money, which is governments, or in the case of the United States of America Federal Reserve. The guarantee of the credibility of the currency they created gave governments a huge advantage: they could always create what everyone would do anything to achieve. Of course, this is not without limits, but the limit of money creation revolves only around the risk of inflation, which can be controlled by objective factors (resources aren’t fully unutilized) or governments can also actively intervene by enacting their handy monetary controls.

However, since it is always a possibility, inflation and hyperinflation have occurred frequently since the birth of money. Most of the inflation comes from the government’s mistake, specifically in the money printing policy. In the past, when silver was still used as coins, governments could collect, melt it, mix it with other metals like copper and lead to increase the amount of money without increasing the amount of the backing silver. There was a time when the “silver” coins had no silver at all. When paper money appeared, the money supply was more volatile and the inflation risk was therefore greater. In the US, the period 1965–1982 is called the Great Inflation period, because of the FED’s money pumping policies [3]. Volatility in the global economy only began to decline during the 1982–2007 period (which coincided with Greenspan’s tenure at the FED), called the Great Regulator, when inflation began to fall, as did the view that we should aim at low inflation. But the emergence of the Great Regulatory caused two streams of controversy, is its success due to the policy of the FED or the ECB (EU Central Bank), or just from objective luck [4]? Besides, the emergence of the 2008 crisis, and then the severe epidemic recession in 2019, raised another question: whether these events were black swans, or were they signs of an even more volatile economic cycle [5]?

The monetary mechanism guaranteed by the government created inflation. Although no one is saying that this is the world order that needs to be unified, both Karl Marx and John Maynard Keynes believe that changing the exchange system will create revolution, which includes violence and many other tragedies, and at the same time it is difficult to predict what will arise from the remnant. Therefore, it may be better to continue to maintain the confidence generated by S&P, Forbes and Fortune rankings, or indicators such as GDP, as well as trusting the global economic system will balance things out properly — which is just an idea on paper. But how long will this belief last?

The idea from the father of Classical Economics, Adam Smith, which goes something like: “economic development was best fostered in an environment of free competition”, died as this school of economics fell from grace, after a series of severe crises that followed rapidly since some governments also believed this same idea. But its appeal and variations continue to be maintained in the belief of many people. For example, according to Keynes, economists are in the habit of assuming that market elements always provide a rational benefit to them personally, so factors such as “belief” are often overlooked. Economic models that revolve around rational factors that always make the best choices for themselves are very popular because they are convenient for calculation, creating the illusion that we can always calculate human and market behavior, and be able to manage them reliably. For example, a game asking 5 players to choose the smallest of all the numbers given, if all players are rational, then they will all choose 0. Meanwhile, we will not be able to find any specific answer if it is accepted that the 5 players above will choose the answer according to their feelings. However, is the economy a simple game of perfect information, and are people purely robot-like rational?

Generally speaking, in making a decision we have before us a large number of alternatives, none of which is demonstrably more “rational” than the others”. Instead, he said that: ”we fall back … on motives of another kind, which are not “rational” in the sense of being concerned with the evaluation of consequences, but are decided by habit, instinct, preference, desire, will, etc”.

Just as in the game of finding the smallest average, if everyone was rational, everyone would choose 0 and there would be a tie, no one would lose but no one would win, Keynes believed that if businesses really followed reasonable behavior, no one can build, buy, barter or borrow anything from anyone. Recklessness, hope, and belief have a bigger impact on businesses than estimates of potential profits (which are, in most cases, inaccurate calculations). He said that, “A large proportion of our positive activities depend upon spontaneous optimism rather than on a mathematical expectation,’ Keynes wrote. And if that optimism falters, ‘leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die”.

But it seems that Keynes’ depression was affected because during the Great Recession, classical economists assumed that “the market will recover as it always is,” and he argues that it was this freedom that led to crisis, and it will drag people deeper and deeper into a dark hole, so government intervention is necessary. Because in times of crisis, any rational calculation yields a modest outcome and pulls everything closer to the answer no one wants, than to a happy ending. Meanwhile, only confidence, which may well be filled with emotion, can pull the spirit out of the crisis. Therefore, to restore the economy, it is necessary to restore the belief, instead of romantically believing that people, or the market, will know how to balance everything rationally, accurately, perfectly and optimally.

Keynes was right, his thought inspired the necessary and proper intervention to save the economies of governments in many countries, help them overcome the crisis, and marked the end of the romantic classical economy. However, given the inherently unpredictable nature of the human economy and society, as well as the limitations commonly found within economic theories, the Keynesian school gradually lost credibility and influence in the 70s when the oil price plummeted, the same period of inflation stagnation occurred (inflation associated with high unemployment rate, different from normal inflation which is associated with low unemployment rate) [6]. After all, government intervention does not guarantee that a crisis can be prevented, sometimes it even complicated it.

However, in general, the current macroeconomics is still combined from two extremes: market economy combined with limited government manipulation. In fact, any claim that goes like “the free market is better” or “the government intervenes is better” is incorrect. All we know so far is that the economy is really complicated, and that the crisis — though no one wants it, every economic theory seems to guarantee to prevent it, and every economist wants to predict it — it always happens in the most unexpected moments.

The New Keynesian School was also brought back into the spotlight when the 2008 crisis arose. And Keynes’ idea of ​​restoring confidence if the economy is to recover from the crisis, is also pursued by many modern economists.

2. Restore confidence

Since the birth of the stock market, people need to seriously rethink how trust affects the economy, as well as pay more attention to the series of economic crises that follow. This kind of market allows trust to creep in more than any other market. You’ll see people betting on the price of corn even before it’s been farmed, betting on empty offices that no one rents, or sometimes pouring billions of dollars into a pharmaceutical company that designs an imaginary machine… Of course this confidence can be influenced by factors in reality, such as government policy or future market demand; and sometimes irrational beliefs will only create a tragedy like the dot com bubble crises or the 2008 crash… but we must agree that there was an irrational force that had a very strong impact on the market. Belief alone is so irrational, as Richard Fuld called for “how to restore trust” in a meeting with Lehman Brothers executives when the company was reported to have lost billions of dollars, it of course failed to change the market, and the famous investment bank subsequently declared bankruptcy. We are not going to say that confidence always benefits the market (assuming wealth is such a benefit), but only acknowledging that confidence has made the market more volatile, indicated by graphs of cyclical fluctuations like the “electrocardiogram” of the market.

Since trust has a significant effect, today people also measure confidence indicators to predict the market. For example, “trust” has been shown to be positively correlated with the GDP index [7]. The Consumer Confidence Index also helps predict the stock market or other markets of similar nature [8]. The CCI is one of the most trusted indicators of future economic forecasting, as confidence shows that people are willing to spend more and save less, helping the economy thrive. Consumer confidence, or citizens’ confidence, has also been seriously discussed, and many works show that “you need to restore confidence to recover from a recession” [9] or “Building confidence crucial amid an uncertain economic recovery” [10].

Although it is not possible to fully and thoroughly explain why restoring confidence helps the recovery of the economy, the experimental results have shown that, indeed when we see people are confident and have mutual trust, the economy is healthy. Even if there isn’t anyone in the world who can really observe the “economy” completely and comprehensively, through those indicators, one can have a vague picture of it. The appearance of indicators on human confidence has made the picture of the economy more vivid, instead of the previous indicators that were biased towards income, commodity prices… Confidence indicators make it possible to see people’s optimism through the numbers, and can be seen as a sign that people are still doing well in a volatile economy.

3. Who will invest in a time machine company?

Although in new markets such as the stock market, housing market, derivatives market… People often participate based on trust, but that trust won’t go to the extent of investing in a time machine manufacturing company. One could be fooled about a portable blood testing machine, but one wouldn’t be fooled by something that far-fetched. However, the way that the modern world moves is challenging any traditional person, because of the success of companies like Microsoft, Apple, Facebook, Google or more recently Tesla, Netflix, Uber, they had all been warned as economic bubbles but ended up turning into billion-dollar empires. The specter of the dot com bubble prevented many from investing in Silicon Valley years ago, but the success of Silicon Valley itself is now inspiring a wave of venture capitalists into new and volatile markets like cryptocurrencies.

If the media conglomerates in Manhattan seem to grow in relation to Wall Street, to the point where many argue that financial and media conglomerates have evolved into interdependence, the rise of the social networks society also affects the growth of the cryptocurrency market. It seems that people’s trust and confidence are under some influence, in order to develop the market. While public confidence can help revive the economy, if it’s misplaced, there’s the potential for massive bubble bursts. The financial bubble is a product of emotion, an irrational phenomenon, but it happens so often and so continuously that we can’t say whether people are so stupid, or bubbles are too easily formed in the current economy. The media has made fictional stories spread faster, reach more people, and this widespread trust makes them look real. But when fiction is too far from reality, a wave of awoken investors can cause markets to crash. Many people have predicted that Tesla is just a bubble and Elon Musk is just trying to prolong the fiction story, which may or may not happen [11]. Still, even Tesla or similar companies have had a moment when they see themselves as a bubble, we can’t ignore the possibility that these kinds of stories can prolong long enough and turn themselves into reality.

In short, it seems that the economy or the entire human society is torn between two extremes of reason and emotion. If too rational, everything can be pulled closer and closer to the recession point. If too emotional, huge financial bubbles will be inflated. Sometimes we tell each other stories to buy time, or willingly together ignore the current situation to bet on a future that hasn’t happened, in the meantime, maybe a happy enough ending could be created.

Or maybe not.

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References:

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[2] P. Allen, “No Chance of Default, US Can Print Money: Greenspan,” CNBC, Aug. 07, 2011. https://www.cnbc.com/id/44051683 (accessed Aug. 13, 2021).

[3] M. Bryan, “The Great Inflation | Federal Reserve History,” Federalreservehistory.org, 2011. https://www.federalreservehistory.org/essays/great-inflation (accessed Aug. 13, 2021).

[4] D. Giannone, M. Lenza, and L. Reichlin, “Explaining The Great Moderation: It Is Not The Shocks,” Journal of the European Economic Association, vol. 6, no. 2–3, pp. 621–633, Apr. 2008, doi: 10.1162/jeea.2008.6.2–3.621.

[5] Ćorić, Bruno. “The Sources Of The Great Moderation: A Survey.” Challenges Of Europe: Growth & Competitiveness — Reversing Trends: Ninth International Conference Proceedings: 2011 (2011): 185–205. Business Source Complete. Web. 15 March 2014.

[6] “Stagflation Definition,” Investopedia, 2021. https://www.investopedia.com/terms/s/stagflation.asp.... (accessed Aug. 14, 2021).

[7] “Trust and GDP,” Our World in Data, 2016. https://ourworldindata.org/trust-and-gdp (accessed Aug. 14, 2021).

[8] “Leading indicators — Consumer confidence index (CCI) — OECD Data,” theOECD, 2021. https://data.oecd.org/.../consumer-confidence-index-cci.htm (accessed Aug. 14, 2021).

[9] George-Marios Angeletos, “Why you need to restore confidence to recover from a recession,” World Economic Forum, Mar. 16, 2015. https://www.weforum.org/.../why-you-need-to-restore.../ (accessed Aug. 14, 2021).

[10] “Building confidence crucial amid an uncertain economic recovery — OECD,” Oecd.org, 2020. https://www.oecd.org/.../building-confidence-crucial-amid... (accessed Aug. 14, 2021).

[11] “Economic bubbles are irrational, but we can understand them | Aeon Essays,” Aeon, 2019. https://aeon.co/.../economic-bubbles-are-irrational-but... (accessed Aug. 14, 2021).