economonkey

This is an article that I could have written a few months ago, when the Bank of England stated its intention to begin ‘queasing’. But it has become rather more relevant now that one of the pronouncements of the G20 summit is that the International Monetary Fund (IMF) will itself begin to ‘print’ additional SDRs (Special Drawing Rights, effectively the IMF’s own currency) which its contributor countries can draw down in the shape of dollars, euros, etc.

Note my use of the word ‘print’ in the above paragraph. The days when first world countries used the printing press to increase the volume of money in circulation have long gone, assigned to eras such as Weimar Germany. Paper and ink are still heavily in use in Zimbabwe, of course, but for countries like the UK, where the notes and coins in circulation account for only about three percent of the total ‘money’ in the system, we’re really talking about digits on a computer screen.

Even so, while the phrase ‘quantitative easing’ sounds nice and strategic, in reality it has a similar effect to printing addition bank notes and throwing them out of the Bank of England’s window into the street.

To take a step back for a moment, let’s look at the main blunt instrument used by policy-makers to control the velocity of money and the rate of growth of an economy: interest rates. Set the base rate low, goes the received wisdom, and people will ‘invest’ their money rather than leaving it idle in a bank account earning nothing (or, depending on the level of true inflation, less than nothing). If the economy starts to run away from itself and bubbles form in a particular investment market, interest rates can be raised, increasing the appeal of saving and reducing the relative gains to be made by investing in speculative markets.

(or “Stop talking us into a recession!”)

In recent months I have read, in newspapers and online forums, and heard, from some genuinely interested people and a few incurable optimists, the proposition that the problems in the financial system are somehow due to ’scare-mongering’ in the press. Depending on your bull/bear persona, it’s easy to agree or disagree with this proposition without actually thinking too much about what it means.

So let’s take a step back and consider the fundamentals. First, the mass media obviously influences public opinion. There can be no doubt about that. If it didn’t, it wouldn’t exist; it would have no political role and no advertisers would be interested in paying to be a part of it. Television and newspapers have finely-honed psychological hooks, and although they’re suffering because of the accessibility of more credible information on the Internet, they know how to drag their readers in with a good, emotional (but seemingly rational) headline and story.

As we know from experience, when every newspaper and television channel is exhorting people to buy into the housing pyramid scam (sorry, market) because ‘house prices only go up’, and using fear and greed to push that message home, it has an effect; first on the psychology of the public and then on the market pricing.

Put two economists in a room together and you’ll get three different opinions on the state and future direction of the economy. Surely economics, the dismal ’science’, could learn something from one of the true sciences, such as physics?

Certainly there have been efforts to do so, particularly among large investment banks and hedge funds, who have used quantitative analysis tools running on powerful computer systems to try to tease out the signals from the noise of price movements, taking into account thousands of different influences from interest rates to tax variations, asset prices to currency exchange rates and much more, all on the basis that there is some underlying predictability, some ‘law’ that governs price movement.

Which makes it all the more surprising that so many of them got it so spectacularly wrong; to the tune of $188 billion and counting. Why?