Richard Posner on "Animal Spirits"

Judge Richard Posner has just weighed in on the topic of "animal spirits." As always, his remarks are worthy of serious attention. Link here.

For my own posts on the topic, link here.

Posner begins by turning the tables on the economists who are worrying about the psychology of market participants.

He notes that the current crisis must be a great embarrassment for economists.

Economists who studied the Great Depression assured us that it would ever happen again. They expressed full confidence in their own abilities to avoid the mistakes of the past.

Which is well and good, except that that does not guarantee against making new mistakes.

Ask yourself this: how many people based their investment decisions on the premise that our brilliant economists could guarantee that there would never again be a Great Depression?

It reminds me of therapists who pretend that if their patients discover why they got it wrong in the past then they will naturally get it right in the future.

I have often argued that this is a fundamental mistake, not least because knowing why you got it wrong does not tell you how to get it right. It tells you want not to do, not what to do.

For all of their knowledge of the past, economists were at a loss when the banking crisis hit. Not knowing what to do, they decided to do everything.

In Posner's words: "Academic and government economists specializing in the business cycle were as surprised by the September collapse and the ensuing downward spiral of the economy as anyone, and were unprepared with plans for arresting it. Six months later they cannot agree on what should be done to recover from it. Not knowing what will work, the government is trying everything."

Eight decades of study by some of the greatest minds in the world did not lead to a consensus. The great economists do not agree on what worked in the past.

Some believe that fiscal policy (increased government spending) is the solution; others place their faith entirely on monetary policy (lower interest rates.)

Some believe that the New Deal rescued us from the Depression; others believe that the New Deal aggravated the problem.

Like a mind divided against itself, the government has decided to try it all, all at once.

But this approach bespeaks panic and sows doubt. Why would anyone feel confident in the future when our leaders are reacting our of fear.

Add to that the fact that the new administration seems more intent on paying off the special interests that gave them power than fixing the banking system.

Telling us that clean energy and universal health care will solve the financial crisis is inane. It ranks up there with the notion that giving new powers to labor unions will impel businesses to hire more workers.

But then again, the Obama administration seems more intent on fixing the blame than on solving the problem.

Does the administration grasp the problem and does it have any real confidence in its ability to solve it? Or does it believe that free market capitalism is the problem and that increased government control over the economy is the solution?

To repeat a point I have made before, the real question is not whether the administration believes in free markets, but whether the markets believe in the administration.

As of now, the answer is that they do not.

Posner described the Obama administration this way: "The intentions are good. But the lack of focus, the partisan squabbling, the dizzying policy oscillations, the delays in execution, and the harassment of bankers are bad."

The markets probably suspect that this administration is more interested in election victories than in economic growth, and, thus far, they have been acting accordingly.