This is a small extract from article about the economic crisis...
It states in part that books on the subject have seen:
"the failure of economists to solve the riddle of the business cycle, but expresses a strong conviction, notwithstanding, that its basic cause will eventually be isolated, even as medical science will assuredly discover the true cause of 'common colds' and so prevent them. (The specific comparison is revealing.) Meanwhile, the most promising procedure (as with colds) is to live wholesomely and carefully. Avoid exposure! Each of us should live within his income, invest with prescient discrimination (never speculate), work assiduously if the opportunity comes, and be patient if it does not - these and similar economic homilies point the way to restoration, and Plenty."
In addition to this kind of "common sense" approach to avoiding future economic crises it also addresses the issue of globalization:
"It might appear that the dilemma, so conceived, could be more accurately expressed as a conflict of economic forces pulling in one direction - towards world unity - and of political forces pulling in the opposite direction - towards world division"
Thus we have the problem of industrial capitalism unifying markets to improve their efficient exploitation while at the same time we have nationalist forces securing their own disproportionate benefit. This is manifested by various pro and contra globalization organizations, both of which have valid positions. The article goes on to discuss topics such as the growing complexity of monetary policy, government regulation, the consolidation of mega-corporations and the liberal extension of debt as major causes to the economic crisis.
All of this is, of course, not anything anyone hasn't read about thousands of times. What is different about this article is that it was written in 1933. BEFORE the extent of the "Great Depression" had been realized. While we believe that our time is unique, our causes different and we romanticize the past, we ignore most of psychological similarities and exaggerate the technological ones - it is, in fact, not very different.
We like to talk about how we now have a more globalized world, a faster communication system and much more complex "financial instruments." The reality is, however, that our instruments are only more complex, our communication faster BECAUSE we have more advanced technology. In short, we make the same decisions and follow the same structure, but we can do it faster.
It is irrational to believe that "this time" we will learn the lessons and build a better system to handle the "new problems" of the "modern age." In biblical times, when technology was poor, information moved slowly and systems were much simpler, the old adage of "7 years of feast, 7 years of famine" was still a reasonable rule, which was, then as now, pretty much ignored. We delude ourselves when we believe that technology, speed of communication and resulting increases in complexity must also meet with advances in human social and psychological behavior. They do not.
Just as the Egyptians had their priests, whose ability to engender confidence in the Pharaoh granted them vast amounts of power; so we have our political and economic advisers who grant the same confidence and subsequently wield similar power - today called "legitimacy." Both priest and adviser have approximately the same empirical track record, but our need for confidence always overshadows our need for evidence. A simple analysis of the track record of financial professionals' ability to predict the future will demonstrate conclusively that their ability is not statistically much better than random guesswork.
What we do is create complex systems which obscure the simple fact that social-psychological systems are difficult, if not impossible, to predict with any degree of usable certainty. Beyond knowing that the economy goes through booms and busts, it is near impossible to know when those events will occur and where. It is so unpredictable, in fact, that although it may not be random, for the sake of practical usability it may as well be random.
Yet with all this information we still persist in long term economic planning, read ever more books on technical analysis, trend trading, investment indicators and so on, as if we were primitives trying to divine the fall of kings by investigating the path of the comet in the sky or evaluating the innards of our favorite animal power. If one looks hard enough one can always find a pattern that indicates the events that occurred were completely predictable based on historic observation. Much more difficult is to produce a record that is forward looking and accurate. I have never seen any such record. Of course we can, post facto, find and produce such records in the same way that we can find mutual funds that did well in the past, but show me the person who can accurately forecast which mutual funds will do well in the future - accurately and predictably. There are enough professional mutual fund managers that some of them will, of course be right with their selection.
Similarly if 100,000 people play russian roulette for $1,000/game, some of them will be extremely rich and the rest will be extremely dead. If you decide whether or not to play russian roulette by looking at the winners and ignoring the losers, it seems like a very safe and profitable game - I think I'll play! Since the losers don't write books like "How to Make Millions in the Stock Market" there is very little investigation into this statistically significant group. I suggest that when you decide to invest that you do so only having looked at the entire sample of winners and losers and compare that to the average return of a major index over that same time period, for example the S&P 500. Mutual funds, stocks, and nearly all other financial instruments do not, in the aggregate, outperform the S&P.
How can this be? The problem is one of overconfidence. Most people believe, on average, that they are smarter than the average. Disproportionately so. This is true when people are polled for looks, chances of success, and just about any other socially ascribed attribute. People also believe that they work harder, have more stress and incur more difficulties in life in a similarly disproportionate way. We overestimate our ability and also overestimate our difficulties. Thus, we are preconditioned to respond positively to flattery and ignore rigourous analysis. That's why when people tell you that the "smart money" is on currency speculation, especially the short term value of the Euro, you think "hey, I'm smart, let me look into that." Now you do your investigation looking for reasons that this advice is correct... surprise, you will find it. If someone now comes to you and tells you that you are being stupid, that you haven't spent enough time and evaluation and, anyway, currency speculation of this type is a kind of guesswork you will ikely require much more evidence from this contrarian than you did from the well-dressed smooth talking flatterer.
About five years ago I seriously considered buying a house. Almost all of my friends, and certainly my family, told me that I should do it. They talked about what a great investment it was, that it's the "american dream" and that I'm "wasting my money on rent." Think of the great tax write off and, besides, housing values always go up. "Have you read the millionaire next door?" they would ask. Yes. But I also read "The Black Swan" which paints a different, and for me, much more compelling picture. The millionaire next door and all the books like it, do what I showed above. They look at the winners, ignore the losers, and find similarities among winners; not differences between winners and losers. This is incredibly bad analysis and leads to obviously skewed results and useless conclusions.
So back to my house. Here was what I did. I decided I would seriously look into house buying. The average house in Colorado at that time was selling for about $260,000. The average household income was about $46,000. The basic calculation for home buying is that you should spend 3 times your annual income on a house. I could find almost no house that I would live in that cost less or equal to 3 times my income. How were people doing it? How is it that although I was making a decent income, didn't have major expenses, I could not make the math work? It really killed me. I must be doing something very wrong. I spoke with real estate agents and lenders and they were more than happy to make the numbers work out. The way they explained it was that the house value would go up, so it doesn't matter that much that the multiplier is 5 or 6 instead of 3. I could get an ARM and then refinance at a lower interest rate and use the increased equity in my house. They spent a lot of time telling me that since 1950 the national home market had NEVER fallen. It was a 100% safe investment and historically the best investment that could be made.
Somehow I wasn't convinced. I think this is because whenever I hear "x has never happened in the past" I assume that the odds of it happening are real, but that the chances that people see it are near zero because they have assumed a position of certainty based on tradition, not fact. The very fact that everyone was telling me that housing values never go down, made me believe that they would go down a lot more than anyone expected. This is how markets work historically. The more confidence in the rise, the greater the fall. Of couse I had no way of knowing when, or even if, that would happen - but my uneasiness won out and I didn't buy a house. I also calculated annual maintenance, upkeep, time spent mowing the lawn etc. and then the decision to rent made even more sense. I don't like mowing lawn.
Today, people are telling me "whatever you do, don't buy a house." "It's a trap" they tell me, "beacuse if you have to move when the market is down, you're screwed." For the first time in my life, I think that it might be time to seriously consider buying a house.
I believe that the changes in the financial and government systems taking place today are merely laying the groundwork for the next economic boom and subsequent bust. What the boom will be, its causes, its beneficiaries and victims is as unknown as what will spur its subsequent collapse - leading, predictably, to more changes which will "make sure it never happens again." Indeed it is ironic that it is the very laying of this groundwork which practically guarantees that the cycle will repeat itself. We are not essentially solving anything, we are merely changing the pattern and making the formula more complex so that we can have confidence in the new structure and are unable to recognize that it is fundamentally the same. I say that without any specific knowledge of either past or future structures, however, one does not have to understand a complex system to rate its merits.
I do not understand the complex systems behind astrological charts that are used to predict a person's life - but I can see that astrologers do not have a record of useable success percentages to merit an understanding of their systems. Similarly, financial and government institutions also have no such record and therefore I deem a complex understanding and evaluation to be a waste of time. If the purpose of a "risk analyst" is to use a complex system to evaluate and avoid risk and the entire system explodes because of unseen risk, what is the value of their analysis, except maybe to avoid it? What is the value in my understanding it when the outcome has predictably and repeatedly demonstrated that the system, however it claims to function, does not serve it's primary purpose. And yet we continue to apply complex risk analysis. Interesting.
I think a far better course of action is to recognize that complex social-psychological systems simply cannot be predicted so we should stop pretending that we can. Instead we should create mechanisms that are adept at responding to unpredictable and irrational events. This way we can react to the changing environment efficiently and minimize the damage.
Also, it probably makes sense to go by the simple rules of living within our means, saving during surplus periods with the knowledge that famine is coming and avoiding the delusion that we can know that which we can not.