The Psychology of Bubbles and Crumples
Wednesday January 7, 2009
William Watson is spot on with his assessment that the current bust is as psychologically driven as the real estate boom was:
If social contagion and information cascades can carry us all off to manic highs, presumably they can also drive us down to unwarranted lows. Yes, there are objective reasons for believing the Canadian, North American and world economies will underperform this year. But, maybe because we're hearing bad news 24/7 on dozens of media outlets, lots of us seem to have persuaded ourselves a return to the 1930s is now certain.Absolutely correct. Good news, a change in societal attitudes, and our CNN civilization (as Watson calls it) moving on to the next 'crisis' (whatever it will be) will do far more to get us out of this stimulus than any government spending program.
In effect, we're in a negative bubble. (I think of a negative bubble as "a crumple.") We're quickly talking ourselves into depression. We've gone from the subprime to the ridiculous, you might say.
Why do I find this encouraging? Because a crumple is no more reasonable or justified than the bubble was. And because it might turn around just as quickly. The wired world we boomers and our offspring have built is famous for its volatility and short attention span. It was just six months ago, remember, that this time it was different and $150 a barrel was the new floor price for oil. Now people are thinking we'll see $20 oil again. Our CNN civilization can't hold a collective train of thought for more than a few months. A few good pieces of economic news might dispel the irrational despond we're currently living through.
Comments
“Why do I find this encouraging? Because a crumple is no more reasonable or justified than the bubble was.”
…On the contrary, ‘crumples’ are justified AND reasonable for PRECISELY the same reason the bubble was, and that is both involve perfectly sane and ‘normal’ decisions made by people in a social environment. IE, people are optimistic when they have reason to believe others are and will remain so as well. Alternatively, people are pessimistic when they have reason to believe others are and will remain so as well. It’s really not that complicated. You don’t even need Krugman’s “s” variable to figure that out.
Just because you can’t make a neat math function out of all behavior, doesn’t make it unreasonable or unjustified!
“…On the contrary, ‘crumples’ are justified AND reasonable for PRECISELY the same reason the bubble was, and that is both involve perfectly sane and ‘normal’ decisions made by people in a social environment.”
Watson makes the exact same argument in the article I linked:
“If everyone about you is losing their mind, well, to paraphrase Kipling, you’d be a fool not to lose yours, too.”
My bad. I suppose in the future I should read the full link haha. But still then, the imagery of “losing your mind” is in my opinion misplaced. Pscyhological motivations does not always equate to “Irrational” ones. I still think there’s this underlying belief by economists etc. that what is happening is irrational and foolish etc., but use of such terminology is really just a way of brushing the hard analysis under the rug. It’s a way of saying, “well I don’t know what’s going on, people are just being stupid. I’ll just let the behavioral economists figure it out for me.”
I should add that in all this talk of “social contagion” the whole idea of risk and uncertainty is not really talked about. In a ‘crumple’, uncertainty is heightened. At first a select few get hit hard - usually people or corporations with some power. Now I have to make a choice then: to spend or not to spend. But at this point uncertainty has risen to a degree that maybe I decide not to spend. My neighbor sees that I’m not spending and I’m worried about the economy, so he does the same, and so on, and so on…. so underlying ’social contagion’ is the very real concept of uncertainty that should not be ignored.