Economic history can be viewed as nothing more than the struggle to structure buying and selling in a world of constant change.
Adam Smith saw “equilibrium” as an achievable state in which those activities were in balance…supply was available that equaled demand. On a small scale, in early industrializing England, that may have been true for a few years, at the birth of the industrial economy.
But since then, economic “levers” — influence points — have become many and their relationships tangled and complex. It is a struggle to describe how the economy works in such terms that a lay person (heck, that competing economists) can agree on. And the relative importance of those levers shifts as the underlying economy shifts.
But make no mistake — the economy is a human creation. It is not a “thing” out there. George Soros calls the human element “reflexivity.” In complex and often hard to parse prose, Soros lays a considerable amount of blame for booms and busts, not on impersonal economic forces, but on …. people.
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The current financial crisis is scary to us because it exposes the economy for what it is.
It is NOT a given. It is an ACCOMPLISHMENT.
A soundly functioning economy is the product of a host of actions: from business owners, workers, government regulators, banks and other lending institutions, and the “back office” organizations that keep everything humming along.
And at the core of this cobbled together structure called capitalism is one word: TRUST!
At the consumer level: here’s an example of trust in the financial system. If you hit my car, I don’t try to steal yours to make up for my loss. I TRUST that GEICO my insurer will handle my claim and I will be made whole.
The same is true at more esoteric levels of the financial system. In the case of AIG — if I held mortgage backed securities, and those securities went down in value, I have to keep more money in my company to balance that out.
And if those securities become valueless — I know that my insurance premiums I pay to AIG will cover my losses and prevent my business from going out of bsuiness. Without that security, well, it becomes too risky for me to lend; it’s more lucrative to just sit on my cash while everyone else who lends goes under.
Would you risk driving a car you if woke up one day and there was no car insurance? Probably not. Could you get to your job? Buy groceries? Go to the gym? And if the government didn’t intervene, don’t you think the economy would tumble? If consumers can’t buy goods, stores will lose money, many will close, jobs will be lost.
Like with Humpty-Dumpty — all the kings horses and all the king’s men wouldn’t be able to put the economy back together again. The trust — and the infrastructure that generated the trust — will be gone.
Same is true in the global economy right now: don’t take this economy for granted if you aren’t willing to invest in the infrastructure that makes it successful.
There is a lot of hand wringing about what has caused the current Wall Street meltdown. I think the explanation is very simple:
It’s like the old story of the frog and hot water: throw a frog in boiling water and he will jump out immediately. But put him in cold water and slowly turn up the heat…and he will die.
Gradual unhealthy change is below the threshhold of awareness…but it can still kill you.
The US financial markets risk levels increased over the past 15 years….the illusory profits of the dot com boom bolstered by an increase in the money supply….which gradually found its way into mortgage backed securities….and to main street via riskier mortgages….household income and mortgage debt became decoupled….housing equity turned to debt….
Every boom crashes because we run out of buyers of high priced assets. The early participants keep the winnings, and the latecomers can’t sell their houses, don’t get the appreciation they counted on….
Law of nature, law of financial markets.
