Herd Psychology of Currency Trading
This idea of herd psychology helped John Maynard Keynes makes sense of the economic bubble that blew up in the years before the great crash of 1929. It can also do a pretty good job explaining our own great financial crash in 2008.
In normal times, any economic textbook now offering Keynes’ time would say if the price of something goes up, people buy less of it. If the price goes down, they buy more. That’s how markets work. Except, Keynes realised, when you have bubbles. Then a different side of human nature takes over. It’s the same that says, “Oh!, house prices are going up. Shares are going up. I shall buy more because the price is going to go up again.” Which, of course, it does. It becomes a self-fulfilling spiral. Prices go up and up and up and up. Eventually, the bubble will burst, it always does.
In the years before 2008, did we forget what Keynes had taught us about herd psychology, Bubbles and the uncertainty of economic life? Did the bankers, investors, politicians and the rest of us simply get too confident in thinking the good times would go on forever?
Alistair Darling “I think inasmuch that people actually sat down and thought about what were the risks, what are the uncertainties, then clearly a large number of people were manifestly found wanting. And, of course, if you don’t know what you’re doing, it’s not surprising that you end up being smashed to bits and that’s precisely what happened.”
Keynes’ big ideas, that countries shouldn’t beggar their neighbours, the markets were unpredictable, all came out of his own experience. Now the Great Depression produced his most important idea yet, and added real urgency to his need to tame the economy. What he really saw, economies might sink and then not automatically float back up.
Looking around the Western economies today, that does sound a bit familiar.
In the early Thirties, the outside world was deep in gloom, with the Dole queues lengthening and factories closing everywhere, but Keynes’ life was blissful. By now he was famous, and he’d shocked even his avant-garde Bloomsbury friends by marrying a Russian ballerina. Up till then, he’d been gay.
Art, books, love affairs, for John Maynard Keynes this was what life was all about. But he understood, probably more keenly than his Bloomsbury friends with their inherited wealth, that money kept the whole thing afloat. You couldn’t have a civilised society without a well-functioning economy. When he was back in the real world on Monday morning, he could see the British economy wasn’t working at all.
Britain had been in a slump for years. Classical economists said that if workers would just agree to wage cuts, businessmen would invest again, create jobs, and the economy would revive. But Keynes disagreed. He thought the way to recovery was being blocked by pessimism, or low animal spirits. The fear engendered by herd psychology was stifling the market.
Sir Mervyn King
Sir Mervyn King “The big insight of Keynes behind all of this was that the market economy is not self-stabilising. When you get very big changes in animal spirits, in sentiment, the people who are producing to sell in the future suddenly worry that actually maybe there won’t be the demand in the future, so they stop producing. To get out of that low output trap can be very difficult.”
Keynes realisation that an economy could stay sunk indefinitely was a radical break with conventional thinking. The classical approach said the economy would get better, we just had to give it time. But looking around, it seemed obvious to John Maynard Keynes that it wasn’t getting any better and it seemed blindingly obvious why it wasn’t. Every time someone lost their jobs and joined the dole queue, they have less money to spend, so that would mean fewer goods were bought. It would probably mean more job losses. You could get caught in a downward spiral with no obvious way out. Now it seems equally obvious to us today, but back then was all very new.
Keynes thought the low animal spirits in the business world were now infecting everyone. In a radio broadcast in 1931, he made a dramatic call for action.
“The slump in trade and employment are as bad as the worst which have ever occurred. Activity and enterprise, both individually and nationally, must be the cure.”
Today, Keynes’ followers have made similar calls. Years after the start of the recession, the economy is still struggling to get back to where it was. You don’t have to be Keynes to see animal spirits are low. Whether his ideas can revive them is another question.
John Maynard Keynes insight that countries could just get stuck was probably his most important contribution to economic thinking. But he didn’t just want to understand economies, he wanted to make them work better. He had plenty of advice for getting out of a slump, but the most controversial was that the governments should spend money they haven’t got. To my mind, the biggest argument in politics today is over whether countries have done too much of that since the crisis hit or not enough.
Mark Brandon, Gila Bend
Keynes might have died almost 7 decades ago, but out here in the Arizona desert, his big idea for getting the economy moving again lives on.
At Gila Bend, they’re building the biggest solar power plant of its kind in the world. The site covers over three-and-a-half square miles. Nearly a million mirrors will capture enough energy to provide 70,000 American homes with clean power. But for the people in this remote region, and for John Maynard Keynes, probably the most important thing this plant will produce is employment.
Mark Brandon “Between my wife and I, we probably spent two years out of work. Thank God, not at the same time but… We took some very significant hits. The company that sources our manpower tells me they receive 300 resumés per day. There’s a lot of people looking for work. And people who have jobs out there are very, very lucky to have their jobs.”
In effect, this plant is part of the vast Keynesian experiment. In the wake of the crash, US government stumped up three quarters of a trillion dollars for projects like this one to create jobs and growth.
In normal times, say the people who run the site, they would have raised the billion and a half dollars to get things going from commercial banks. But these aren’t normal times.
Armando Zuluaga “Because of that downturn, we had to, look for alternative sources of financing. And, of course, in this context the federal loan guarantee program here in the US has helped a lot. In fact without that kind of public programs plant would have never been a reality.”
Now we’re used to governments using their cash to try to bring the economy to life in hostile environments where private money is drying up. But back in Keynes day, it was much more controversial idea.
In the 1930s, Keynes spent weekdays at his home here in London’s Bloomsbury district. He wrote countless articles and pamphlets explaining how something cute should be done to tackle this Great Depression. In normal times, Keynes thought monetary policy was the best way to help the economy. You cut interest rates to encourage people to borrow and spend more and companies to invest. But when animal spirits are really low that might not be enough. Companies might not see the point of making new investments, people might not want to borrow no matter how cheap it was. That’s when Keynes thought government did need to make up the gap with more public spending.
Keynes suggested the government should hire people to demolish South London and then rebuild it. He wasn’t serious, but he was making a serious point. If the government borrowed to create jobs, people would spend more, confidence would rise, and the economy would recover; the feel-good factor of herd psychology. If you picked the right moment, he insisted the extra spending would pay for itself by producing higher tax revenues.
External Links
Herd Psychology – Wikipedia Page
