Thursday, August 11, 2011

Simple brain economics

Two days ago, a geek parading as an economic expert appeared on TV to tell us that the new policy of the ECB (European Central Bank), of buying Italian and Spanish bonds, had worked and that the markets had stabilised. Less than 12 hours later, the great sell-off began, with French banks taking the biggest hit and France’s AAA rating being questioned. So much for the expert.

The truth is that the policy of the ECB and all other policies currently on the table will not work. Only a policy that takes into account brain realities will. I do not say this as an economic expert, which I am mercifully not. I say it based on a much simpler economics, brain economics which itself is based on profit and loss and confidence and reliability. These, it seems to me, are simple and basic factors that the brain has evolved to assess for millions of years. Most brains understand little about the fancy mathematical economic theories developed by artificial intelligence laboratories, and which have proven to be such a disaster – in fact, they may have contributed significantly to bringing about the economic crisis.

Let us suppose that, to finance my extravagant life-style, you lend me £100,000 at 4% and find that, because of my low earnings, I am unable to pay back the interest, let alone the loan. Instead, to service the interest, I come to you for another loan, this time at 6%. You may think me a little nutty and unreliable. However, if you know that I have huge realisable assets – say, land and castles - which I could sell off come the crunch, you might lend me some more. But then you find that I return with a further request for another loan, to service the interest on the outstanding loans, because I am unwilling to tighten my belt. Your confidence will evaporate and my credit rating will go down; you (or your brain) would have calculated correctly. You would rightly ask me to tighten my belt, sell off my assets and balance my books. Your brain will have calculated that I am not credit-worthy, and you would lose confidence in my ability to repay. All promises I make would henceforth be worthless.

This is all there is to it. It is an exact analogy to what is happening, and all this talk about buying bonds here to sell them there and the rest of it is junk talk. This is why all buying of bonds, and raising debt ceilings and lending more money, will not work. One does not need a sophisticated degree from Harvard Business School to realise that.

And quantitative easing?
This means printing money. It, too, will not work and never has except as a temporary palliative which only makes matters worse in the end. All ordinary brains, without the advantage of sophisticated degrees in mathematics and economics, know that printing money simple reduces the value of the money we have, and therefore increases prices. And hence, people with ordinary brains simply take refuge in something that is unlikely to be easy to clone, like gold. All this does not require sophisticated thinking. It amounts to simple and reliable brain calculations.

The one reasonable statement I have heard from an economist came on the BBC today. He said that “markets are finally catching up with reality”. Even that is incomplete, for what reality is this that he was talking about? Well, let me provide the answer: brain reality!

Maybe we should dispense with all these economists once and for all. To paraphrase what a friend of mine said about another friend, “I never believed in artificial intelligence until I met economists”.

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