The Great Financial Mirage

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“A street sign pointing to Wall Street in black and white” by Chris Li on Unsplash

The glue that holds our current monetary system together, that patches its questionable holes and sews together its discordant parts is nothing but communal trust. Public confidence in the paper bills in our pockets, in the credibility and solvency of our neighborhood banks, and in general society at large to keep playing the game the way they’re playing the game is arguably the largest element responsible in bracing our current financial system. Without it, the entire enterprise (or mirage, depending on how you look at it) would undoubtedly crumble.

After all, what often holds the markets up is a heady dose of optimism and not so much technical fundamentals. (Which is why there is so much hand-wringing about investor confidence slipping.) What is worrisome, however, is the degree to which confidence is perhaps the only thing standing between us and economic demise. Warning of financial apocalypse is no new business, but it bears mentioning that whatever the current business mood and newly published sunny employment data, the American economy has long been structurally unsound. (This is not actually, a particularly radical claim, even if it is initially surprising.) Tax cuts will not be enough to change it nor will stimulus packages or slashing regulations. The same disease that nearly crippled the economy in 2008 is still simmering underneath the surface, and arguably, this time it’s a more dangerous vein of it.

On Wall Street, you’d be hard-pressed to locate any strain of the community-style banking culture of yore. This flashy, high-stakes part of the financial system could care less about providing the basic financial needs of the public. (And truly, the actual financial needs of the public are usually quite basic.) In America, the financial sector (in particular, investment banks and Wall Street firms) constitute an obscenely large part of our economy, a part that expands every year. It is not clear, however, that the growth of the financial sector improves productivity or otherwise enhances wealth to any degree. After all, finance is something of a zero-sum game. If you win, chances are, that’s only possible because somebody else has lost.

I hear Wall Street upbraided often as “immoral”, as if the people and individual workers that constitute the system are corrupt and purposefully unscrupulous, greedily laying bare their plan to “take for themselves” and deliberately “exploit the middle-class”. I don’t think it’s that simple — and I certainly don’t see the vast majority of those on Wall Street as terrible human specimens as some are wont to propose. For the most part, Wall Street is a game and people want to keep playing it — they want to keep the game going. Most of them don’t have nefarious intent, maybe they’re just scared! After all, what happens if it stops? The whole thing collapses and nobody wants that to happen! Thus, continual motion is necessary — and so is turning a blind eye to questionable practices, to ridiculously complex and unsound financial products, to the very health of the system altogether.

Nobody has an incentive to speak against the system and to ferret out its corruption, and this seriously bears repeating. So long as everyone keeps playing the game this is all that matters. So what if things don’t look good? Keep smiling and keep transacting, for there is no incentive to do otherwise. Nobody wants to kill the party and certainly nobody wants to prick the public mood. The most potent force in the financial system, after all, is psychology; it’s the most powerful weapon in the toolbox. If people decide they aren’t confident in their investments anymore and start to pull their money, a vicious spiral commences wherein this paranoia leaks and spreads to those around them, engendering a powerful ripple effect. Psychology always multiplies and amplifies effects in a system as interconnected and plagued by a lack of true, honest, stable fundamentals as the financial sector.

In fact, psychology can have such a strong effect that it can essentially create a mirage of what actually exists. For instance, if an entire system of people are willing to shove under the rug the underlying truth of the matter, then a manufactured game can continue to be engaged in. All one needs are mass, willing participants and a handle of public leaders and spokespeople to keep perpetually cheerleading the economy. If this semblance of normalcy can be maintained, the occasional doomsayer prediction will fall mostly on deaf ears.

The Federal Reserve, while supposedly a neutral arbiter of the economy — a cooly distant, impartial steward calmly selecting interest rates with a veneer of scientific rigor — is really far more of a purveyor of political ideas and economic mood. Every six weeks Fed officials congregate and most importantly, discuss whether to move the interest rate. Barring whether or not we should have some paternalistic institution somewhat arbitrarily plucking interest rates, the fact remains that this event is heavily watched by investors, and in particular the financial institutions. It is so anticipated, in fact, that the Fed takes great pains to handpick delicately specific phraseology. So much as the tepid adverb “somewhat” included anywhere in the Fed’s routine statements can easily translate into a noticeable jump (or dip) in the market. Fed officials have a remarkable degree of power in affecting the public’s level of optimism (or pessimism) about the economy. A smallish hike in the interest rate can contract the economy at will and likewise, a smallish cut can induce an expansionary effect. Interest rates, mechanically imposed as they are, are objectively nothing more than pure market manipulation. They are a powerful weapon. And because people impose them rather than the market, the effect is almost always artificial. Simply put, that’s generally one way towards encouraging the game and perpetuating the mirage.

The Federal Reserve is far more wrapped up in politics than one might naïvely suspect. Though technically an independent institution and subject to little governmental oversight, presidents and other political figures have all the incentive in the world to curry favor with the Fed officials and in particular, the chairman. It is common practice, for example, for the Fed to push rates lower if a current president is seeking reelection for a second term, thus boosting the economy and raising the public mood, instrumental in securing a political success. Active political figures also have reason to continually frame the current economic situation in as golden a light as they can. It would reflect badly on them, after all, if it were revealed things were worse than expected. And as long as everyone believes things are churning along mostly smoothly, there is no cause for concern. Because after all, mirages are harmless if everyone believes in them. Thus, the most optimistic statistics are chosen to be blazoned on the headlines without regard for gloomier forecasts (or the hard diagnosis — that our economy is structurally unsound and littered with unsustainable debt, for instance). What’s more, nobody ever suspects that the economists (those gathering and analyzing the data) would be anything but completely objective and politically impartial, but this is naïve and sadly, not the case.

The lesson was clear in 2008 and it essentially had to do with the concept of gravity writ large — what goes up must come down. If we insist on manipulation (e.g. interest rates and quantitative easing) and fabricated confidence when none is especially due, then our complicity in playing the game and participating in the mirage will surely engender destruction somewhere down the road when things start to slip and the spiral starts and things come landing back on the ground with a resounding thud.

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Writer of economics, psychology, and lots in between.

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