What is impossible in physics is possible in the complex world of the economy: something could happen just because people believe in it. Self-fulfilling prophecy works. If everyone believes that prosperity is around the corner and acts accordingly, that is, they start buying materials, produce, and employ workforce at full throttle, prosperity will indeed become a reality. In such a world, Baron Munchhausen can indeed drag himself out of the swamp by pulling on his own hair. Or, what is equally impossible in the physical world, Lazy Dick can save himself (temporarily) from the waterfall by blowing into the sail standing up in his boat.
But it could also work the other way around. If, in anticipation of hard times, everyone saves and pinches pennies rather than investing and they also cut back on spending, recession will indeed come—no one is buying, and there is no one to produce for. Even when otherwise nothing was wrong. Therefore, beliefs and expectations are immensely significant for the current and future state of the economy. And that may give rise to plenty of odd things. For instance, similarly to cartoon characters, economies (and exchanges) tumble down the pit not when they have lost the ground, but when they actually notice that they have. Both can spend a long time with their feet flinging about in the air without falling. Their belief that they are still standing on firm ground holds them in midair for a long time.
However, this does not mean what believers in financial conspiracy theory are so eager to read into it, that the whole thing is sandcastle building, illusion and false reality. The smartphones, aircraft or skyscrapers created by the complex system of the economy are actually quite real. They are simple created in a system responding to its own reflections on itself.
Consequently, in the world of investments, gaining access to any information on expectations is extremely important. Answers are obviously never certain. But to divine that the economy no longer rests on solid foundations and is held in midair only by widespread and general belief, is extremely valuable knowledge for us. This is because sooner or later it will fall down, and if we prepare in good time, we can save ourselves from huge losses.
Of course, things are not that simple. Even if we do notice that expectations have got unanchored from reality, the world may still go on deluding itself with empty dreams for a long time. Then of course the later the purple haze disappears, the greater the problem will be. For example, the people of Atlantis maxed out the detection of the approaching disaster:
Naturally, a similar mindset cannot only be adopted regarding the economy as a whole, but also its subfields, the price of specific stocks, or anything where expectations affect the status quo. If we hit upon an area where the majority insist on the same views, we should immediately become suspicious even if we do share those views. In such a case, we must ask ourselves whether we are still standing on firm ground or we are only being held in midair by our beliefs.
One of the fields I am currently concerned with is the general trust placed by the developed world in the stable value of money. Everyone is very calm about inflation. Indeed, we are worried about deflation. That is despite the fact that policy rates are at zero everywhere, and central banks have flushed the world with massive amounts of newly printed money to mitigate the effects of the crisis. Sooner or later, that should lead to soaring inflation.
Supply of money with zero maturity (MZM) – Billions of USD at present value
Source: Federal Reserve Bank of St. Louis
The chart shows the development of the inflation-adjusted MZM supply of the US over the past 50 years. MZM (money with zero maturity) means the quantity of readily disposable money including cash, scriptural money, money market funds, and anything available immediately at no loss. Since the early 1980s, even adjusted for inflation, the supply of money has been increasing steadily (the same holds true for its percentage of GDP), and today the country is sitting on a larger pile of dough than ever before. The US will soon be engulfed in money like Uncle Scrooge.
Despite that, no one seems to be afraid of inflation. Everyone is cool and nobody worries that the money they have hoarded will be worth nothing next year. The situation may be just the opposite of that prevailing in the 1980s at the peak of inflation. At that time, putting the brakes on rising prices and eliminating inflation expectation was a painful process. Just as people then firmly believed that inflation would be permanent, they are equally convinced that there will be none. We have become so used to stable prices that as a self-fulfilling prophecy, they actually remain stable.
Nevertheless, I am concerned about inflation. Currently, mankind is capable of producing all kinds of things very cheaply. If, however, a supply shock occurs for any reason (such as a war, extreme weather, increasing protectionism), the vast amounts of money stashed away on bank accounts will immediately be channelled into the real economy, generating a more intense price hike and inflation spiral than is usual at such times. The Fed is helpless, because by raising the policy level it would send the indebted economy into recession. Like Atlanteans, we sit back and watch the disaster happen to us.
In an old Monty Python sketch, the hypnotist El Mystico puts up housing blocks with a flick of the wrist, which are then held together by the strong belief of tenants. For the time being, we firmly believe in the stable value of money, and the house built by hypnosis does not so much as crackle. But it will collapse in a moment once our belief in it is shaken.
The wholesome cases referred to in the argument can be viewed by clicking on the names below:
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