Friday, June 5, 2009

Laugh Out Loud

As we all know, human beings tend to make rational decisions based on their self-interest. Using this assumption, professional economists have been able to calculate aspects of human behavior that had previously been considered mysterious.

While no one is going to question the calculations, some thinkers have been questioning the basic assumption. As Prof. Lawrence Mead puts it in a recent review, if human beings are not making decisions based on a rational calculation of self-interest, that would imply that economists have made a fundamental mistake. Is that the reason, Mead states, why, in the current crisis, economists seem to have failed us? Link here.

Is there more to human motivation than individual self-interest? Is the figure of the self-interested rational calculator more mythic than real? If so, then what is the alternative?

According to Mead, among others, people are not merely motivated by self-interest. Beyond our self-interest each of us has a vested interest in the orderly functioning of the markets and of society. The economists' mythic being distorts humanity because it lacks an ethical dimension.

The current crisis has been produced by people seeking to craft their lives according to the this theory. Too many people were lulled into believing that if they each followed their self-interest, while ignoring the larger consequences, then the markets would take care of themselves.

In one sense the markets always do take care of themselves. They correct. Sometimes they correct violently. If this costs you your savings or your house, the markets really do not care. Markets are not in the business of taking care of us.

The current crisis has revealed a seriously frayed social fabric, an absence of meaningful human connections, and a group of seriously self-absorbed individuals.

Our financial system was undermined by a culture that taught us all to value Me over We.

As Mead put it: "Morals, not just calculation, have broken down in today's crisis. Borrowers and lenders no longer trust each other enough to do business. To establish or restore trust requires civic virtue, something that today's economics, based as it is on egoistic calculation, cannot explain or produce."

And Mead warns that a breakdown of the social ethos is moving us closer to the underdeveloped world. "A lack of trust and civility is one reason markets fail to make people rich in the less developed world."

Do you believe that human beings are rational calculators, and that they will always act in a way that serves their self-interest? Here is a way to test yourself.

We have all heard sage economists say that the Chinese government will never do anything to sink the bond market because it owns so many American bonds. We would never expect a rationally self-interested party like a government to cause itself to lose money, would we?

But consider this. It may not be a good idea for China to devalue its holdings of American bonds or to crash the bond market or to cause a run on the American dollar. Fair enough. But why would it sit idly by and allow the U. S. government to inflate the dollar to the point where its investments will inevitably lose value?

This week's most important speech was not Obama's oration in Egypt. It was Treasury Secretary Geithner speech to college students at the University of Beijing.

When Geithner asserted that he still supports a strong American dollar and that Chinese assets invested in U.S. government debt were safe, the students in Beijing laughed out loud.

Anyone who is looking for the next black swan, the next improbable event that will cause a calamity, would do well to pay heed to those laughing Chinese students.

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