Monday, March 17, 2008

Economics: Chaos and Optimism?

I had the post below drafted out, but I don't think I've got the time or energy to put more thought into it. I'll throw it out as an "open draft" for perusal/comments, while at the same time linking to this rather nice write-up of the financial mess we're in. What strikes me most is just how much of a chaotic system this is. What seems like a small move has had (or is having) gigantic repercussions. But is this embedded in the philosophy of investments? Check out these two paragraphs from the article:

They made $100 million bets with only $1 million of their own money and $99 million in debt. If the value of the investment rose to just $101 million, the investors would double their money.
Many of these bets were not huge, but were so highly leveraged that any losses became magnified. If that $100 million investment I described above were to lose just $1 million of its value, the investor who put up only $1 million would lose everything. (emphasis = mine)

Question is, why were people making those kinds of gamble anyway? Greed? False sense of security? Necessity? Probably a bit of everything, from what I can gather.

Markets still seems based largely around optimism from what I can see. In that sense, they're not too far away from faith-based religious institutions. Maybe Richard Dawkins should write a book about them.

Us Bank Bear Sterns has been sold at a huge "discount" - think Primark now, but for investments. The FTSE 100 has finally dropped below 5500 as a result and could be set to go lower if this paragraph is anything to go by:
Sterling was the only leading currency not to rise against the dollar as investors feared problems in the UK’s own financial sector.
The Euro, the Swiss Franc and the Yen all "rose" (or, rather, stayed the same while the Dollar jumped off the nearest skyscraper).

What does this mean? It means there's most uncertainty in the UK about what lies ahead. After selling off our all own industry, it means (as I see it) we're generally a lot more dependent on the choices made by other countries - including the US.

What intrigues me is the difference between market prices as "actual price", and market prices as an indicator of just how jittery everyone. Knowing things are going to go bad is very different from fearing things are going to go bad. If you know things are going to be bad, then you can make strategic decisions - the question is not should you spend the cash, but how you spend it. Sure, you may spend less, but there's more certainty, more unexpected shocks.

On the other hand, fear goes hand-in-hand with uncertainty. Instability means that people keep cash back in case of those unexpected tremors. Cash becomes a reaction rather than a strategy.

What stage are we at? Are we afraid of a recession? Or are we knowingly headed towards one?

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