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Posts Tagged ‘Economics’

Fear and hope, and the value of pretend things

With the unfolding of this crippling of the global economy, I’ve been thinking a lot about the mechanisms that drive our economy, and how dependent they are upon the fickle human psyche. That is, how fear, hope, and uncertainty drive the value of “real” things (like a house or a bushel of wheat) and “unreal” things (like collateralized debt obligations or credit default swaps); and further, how these emotions drive the value of markets at large.

Of course, it’s given that no item, “real” or not, has an objective monetary value; items are worth what someone will pay for them. Even a dollar, whose monetary value is a dollar,  is worth different amounts of euros and pounds depending on sentiment in the forex markets.

That sentiment may be partially informed by political developments, economic currents, social restiveness, and plenty of simple human uncertainty.  And it bears an irresistible downward and/or upward force on the American economy in relation to the global economy, and then, circularly, on sentiment about the economy at large.

Take the stock market. (No, really – take it.) It is a fascinating study of human psychology.  It’s where intelligent, educated, rational people make irrational individual decisions, and large groups of these people can collectively, drastically alter the worth of an asset (whether real or imaginary) through widespread patterns of fear or hope.

Anybody 800px-NY_stock_exchange_traders_floor_LC-U9-10548-6who went through business school – and perhaps undergraduate studies – and perhaps even high school economics – knows that one buys low and sells high.

So why on earth do we see panicky selloffs that can slash the value of the stock market more than 20% in six and a half hours?

The smartypants wait for everybody else to descend into hysterics to start spending their money. Warren Buffet has this one on lockdown. “A simple rule dictates my buying,” he has said. “Be fearful when others are greedy, and be greedy when others are fearful.”

Not that Warren Buffett doesn’t make mistakes on occasion. But give the man props for keeping his head when experienced stock traders swoon, and for recognizing the influence of others’ avarice on the value of his and their wealth.

That mechanism remains the same. But today’s stock market is a whole new ball game on a whole new playing field.

Paul Wilmott in the New York Times observed:

Buying stocks used to be about long-term value, doing your research and finding the company that you thought had good prospects. Maybe it had a product that you liked the look of, or perhaps a solid management team. Increasingly such real value is becoming irrelevant.

With the advent of complex algorithms and high-speed computer systems, not to mention the ability to disseminate and access industry gossip in half the blink of an eye, the stock market has become less like a rational exchange of assets and more like a multi-user domain for a game played on exploiting human emotions.

(P.S. To draw a specific parallel, in multi-user domains like Second Life, imaginary stuff has real-life monetary value. For instance, you can bid on a private island or other real estate in the virtual environment using real-life dollars. Similarly, in the stock market, conceptual objects like derivatives are dreamed up by men in suits and then become fungible via real-life dollars.)

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