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What Do I Know About This Stuff?

August 13, 2012

So I don’t have a background as an investment banker and if you were to take a look at my resume you would see I have a degree in Sociology with post-graduate courses in regional economic and social development as well as having taken a years worth of courses in psychology. So I am not an economist, but in a sense I am, because economics is ultimately the study of human decision-making with regard to goods in conditions of scarcity. Robert K. Merton set the precedent for me. As a sociologist his most famous contribution was the formalization of the idea of the self-fulfilling prophecy. The idea is that a statement given as true, even if initially false, can become true if the statement itself changes behavior in such a way as to validate the false premise. Intriguingly, to make his point Merton used the example of a run on the bank in the days before deposit insurance. A bank can begin the day on a sound basis with ample capital. A rumor that a bank is unsound, although false, can start a stampede of depositors trying to get their money out all at once. Now I have encouraged many of you out there who know me personally to take your money out of these zombie and into a credit union. I must however, add the disclaimer that even credit unions do not maintain 100 percent cash on hand, so a true bank run can force any bank to close its doors in the face of depositor demands. Now to understand how this works or why this works you would have to understand fractional reserve banking which is a topic for another article. So the bank that just experienced the run would fail by the end of the day, thus validating the rumor even though the rumor started out as false. And so here we have economics, sociology and psychology involved in this scenario where the interaction of the rumor, the resulting behavior and the ultimate bank failure is an illustration of a positive feedback loop between information and behavior.

Now this doesn’t mean that today a rumor is going to put a bank out of business. In fact, one of my articles here is about the nine U.S. banks that are insolvent and has anybody made a run since I posted it? Even Max Keiser has been yelling at everybody via the airwaves of the insolvency of these too-big-to-fail zombie banks and has there been a run en masse? Frankly, I think with the “dumbing down” of North America people are too busy drinking the flouridated 2012 Olympics kool-aid while chewing the aspartame laced gum and chomping down on their hormone injected Big Mac to even have a clue. A liquidity crisis on the part of Bear Stearns or Lehman Brothers means nothing to the average liberal living in a major metropolitan city working at the local non-profit for less than the national average annual salary. They’re more scared of the shooting that occurred the other night at the local bodega and seem to take global finance for granted or simply don’t understand it and certainly take for granted the strength of the U.S. dollar and certainly don’t understand that paper currency is not money, at least not according to the United States Constitution of which nobody has ever even read and of course all these calls for civil engagement do not even once include workshops on learning whats actually written in the United States Constitution. It’s just a piece of paper written by a bunch of wealthy white men who held slaves, that’s all they understand, what a tragedy.

As a masters student of psychology I can also say my skill is transferable to economics thanks to the pioneer work of Daniel Kahneman, Amos Tversky, Paul Slovic and others who in a famous set of experiments, showed that subjects, given the choice between two monetary outcomes, would select the one with the greater certainty of being received even though it did not have the highest expected return. In this experiment participants were given the prospect of winning money structured as a choice between: A) $4,000 with an 80 percent probability of winning, or B) $3,000 with a 100 percent probability of winning. If we used market theory, we see that winning $4,000 with a probability of 80 percent has an expected value of $3,200 (or $4,000 x .80). Since $3,200 is greater than the alternative choice of $3,000, a rational wealth maximizing actor would choose A. Yet, in one version of this experiment 80 percent of the subjects chose B. Clearly, the majority of people favor financial security even if its theoretical value is lower. Look at the folks at my job, everyone complains they don’t get paid enough for all the work we do, but they don’t even have a background or degree in the field of social work or sociology so why do they stay?! They could very well go work at a bank or investment firm, but they don’t because they are afraid of the unknown, at least at this job they know what to expect. So they stay at a lower paying job because its more secure and they are insecure about taking the risk for something better.

So social psychologist Kahneman and colleagues also introduced a new vocabulary to the world of economics, including risk aversion, anchoring, isolation, framing, heuristics and even prospect theory. Psychology in economics is used all the time, for example, Bernanke’s campaign to raise inflationary “expectations” by printing money and devaluing the dollar while holding rates low or business reporters applying a more favorable spin to business news. Obama appointed Timothy Geithner professed a “recovery summer” back in 2010 and as of this writing we are now in the summer of 2012 and there are still forty-four million people on food stamps. These are all examples of what Kahneman called “framing” an issue to tilt the odds in favor of a certain result.

So perhaps the best way to legitimize my expertise is to look at me as a behavioral economist. With a degree and post-graduate work in sociology, economic development and psychology I would say that’s a fair assessment, some may not agree or simply ignore or scoff, but keep in mind that behavioral economics possesses powerful tools and can offer superb insights and I dare say that the insights offered on this website are not too shabby especially for Joe Average who needs to be informed but doesn’t have the wherewithal to be picking up the Wall Street Journal everyday. So there you have it folks I am a behavioral economist, now you all have a good day and keep checking back for more articles and stay informed as we are fast approaching some very tought times.


From → Economics

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