ECONOMISTS AND POLICY MAKERS FAIL THE "RATIONALITY" TEST

Musings from a frustrated economic mind…Deal with it!

Insanity is one thing, questioning whether irrational behavior is the new norm and pondering whether this makes it rational is another. Huh? 

 

I guess what I am asking is have human beings developed a new ability to blur the line between what is rational and what is irrational? Huh? 

I mean if a human being were to deem irrational behavior as acceptable in certain circumstances, how would this clearly irrational behavior be defined?

How can one define the accepted irrational thought that it’s a certainty that housing prices will continue to rise, as will the stock market and corrections in either are a mere glitch in what is always a long term positive trend. It is a given right? History tells us so, and so it goes, so it is and so it will be.

It seems to me that no matter how many times I read the introductory paragraphs the complex questions, human intuition or the way human beings rationalise for decision making defies logic. OH NO!! Here we go again… “Logic”, isn’t that just as loose a term as rational? How is logical, illogical, rational and irrational behaviour measured in the investment game? Is it segments of time? The amount of profit or loss on trades? How close you go to picking the high or low?

Let me explain by posing another question on top of the 20 I have already asked. Prior to the tech bubble bursting the NASDAQ soared to obscenely high and unsustainable levels, at least in the rational and logical mind of PHIL. Surely it was obvious and “logical” as IPO’s were launched and stocks valued at 80, 100,200x earnings, heck some didn’t have earnings that a massive bubble was being inflated and that eventually people would be hurt? 

So who was rational and logical with their investments? With that meteoric rise was it rational to be buying half way into the rally even though it was clearly, logically and obviously overpriced?

Think of the opportunity lost, 50% of upside before it burst! When I think about this scenario, my behavior into the lead up to that crash, into the bursting of the housing bubble, and now into this new Fed induced cycle I find myself searching for clarity. Could it be possible that I am missing opportunity due to my conservative over analytical bordering on obsessive compulsive approach to what is rational and irrational? 

I know my investment decision making process all too well.  The process is a structured sequential one in which my mind rationalises decisions on a risk reward basis whilst calculating the opportunity cost of multiple investment opportunities all at once as my first two check points in a decision. Thinking through my last investment decision my process works on autopilot and simultaneously seems to apply some kind of weighting to a boost on the upside outside of where my normal “rational” expectations are. Calculate, calculate again, compute, apply, think

.

I said THINK! Is that how you decide where to invest and if you don’t what is wrong with my “rationality” in the way I reach my investment decision? I am sure there are many reading this saying Phil is off his rocker, how could he possibly use those factors when blah blah blahdedy blah are clearly more important…. After all housing prices will always go up long term! So will the stock market! HA!

 

 So what is the blah blahdedy blah?

Sheesh!!! Here I am pondering why people are blind to the fact that it is decisions based on assumptions and acceptance that drive markets through herd mentality, produce bubbles and finally burst them. Should I be saying toss Phil’s rationality out and start afresh? Should I at least consider it given my sense of rationality is different to that of the herd? That makes it irrational doesn’t it? Ok enough of the prodding and poking surely you are following now? If you are still confused I do not know how else to say it! What is there not to understand? Re read and analyse logically one step at a time!

My wife calls me a complex thinker, I turn a decision making process inside out back to front and upside down. I see method in my madness, she just sees the madness. The fact is I am different, but ultimately if I am different to you then surely the same applies and by default you are different to me? If that is the case, then it would follow that our views and perceptions of rational and irrational, logic and illogical differ…. Problem solved! Agreed?

It goes without saying that assumptions of a global set of human rationality guidelines or rules that govern behavior is crazy. We live in a dynamic globalised economy dominated by volatility, creativity. We live in a world where anything is possible if we dream it to be, a trip to the moon even. If anything is possible then obviously nothing is certain, not even that house prices will keep going up forever along with the stock market! So WHY do people “rationalise” and accept this to be?

We are not clones, nor are we robots and economists are wrong in ignoring the massive impacts that go with their fixed thoughts on the dynamic and largely independent process of how an individual meanders through the decision making process. It is perhaps misguided that the “sometimes” periods of herd investment mentality and manias pass off the wrong impression that behavioral decisions follow set patterns… but they don’t, we are different!

So if we are all different, individuals then how the heck can we really guess when the next crisis will hit absolutely and accurately? How can we determine the size and magnitude? I think it is going to be big and I think it will be soon, but perhaps I am just a doomsayer, a glass half empty kind of guy. I am not always like that by the way, I can be fun at parties! My point is an economy is made up of millions of different individuals with different views on rationality, normality and logic. These individuals make decisions that drive the economy of the world.

Economics is a social science because its main participants are people, human beings that have thoughts, feelings, beliefs, traditions, religions, race, circumstances, perceptions of what is moral and immoral and so on. All of these factors drive what each individual sees and feels is rational and irrational, logical and illogical behavior. They also drive what John Maynard Keynes described as “animal spirits”, his attempt at explaining the human aspect and influences to an economy.

Keynes described his “animal spirits” in his famous 1936 book “The general theory of employment, interest and money”.  Keynes asserted that policies should be directed at altering the way people behave in a time of depression or boom to try and smooth out the destructive economic cycles of the past. 

The theory itself has merit in the sense that if it was herd mentality that inflated the bubble, then policies aimed at mustering the herd again to drive them in a different direction may well be achievable. Can animal spirits truly be tamed and controlled? I think not with the handful of tools Keynes proposed as possible solutions. My “rationalisation” in deeming it not possible is derived from my belief that you can’t apply a math equation to social science and expect it to work. I find it amusing how many economists look retrospectively at data after a crash and torture statistics until they eventually conform and support their points of view. It really says that many of the so called experts really don’t have the foggiest!

It goes without saying that everybody fails at something at some time in their lives. I am constantly humbled by new learning experiences. I say that because even the best of plans based on what appears to be a logical and rational theory, produce outcomes that disappoint. Why they disappoint is irrelevant to this discussion, what is relevant is that no matter how much I rationalise and believe does not assure the desired outcome will be achieved.

It is true that economics is a social science based on perceptions. My whole blog has been a journey to show you that everybody is different, so the word rational should be excluded from any economic theory and that includes the work of Keynes. It is ironic that Keynes himself identified the human aspect of the economy in his “animal spirits” explanation only to rationalise or propose solutions that HE had thought would work to unleash HIS version of those very spirits.

So I say that economists and policy makers, as is the case with most self-centred human beings have concentrated and focused for too long on everything but finding out what it really is that drives human psyche, then ultimately behavior

I hope that by illustrating MY process of rationality you can see it is human nature to assume everybody else in the world thinks the way you do, believes in what you do, behaves the way you do… but the fact is they DON’T. 

It is misguided assumption that a group of central bankers and government policy makers know what I am feeling, or you are feeling and why you are behaving the way you are or that Keynes understood how the economy would work almost 8 decades after his book was released and first discussed. Surely that has to be irrational? or is it rational?. 

AHHHHHHHHHHH Can somebody bring me a rationality test to find out and whilst you are at it send it to economists and policy makers.. I am sure most would fail it!