Director MBMG Investment Advisory
Is the Fed a Cult? - Part 1
Neo-classical economics: An approach to economics that
relates supply and demand to an individual’s rationality and his or her
ability to maximize utility or profit. - Investopedia1
The Fed is a cult based on neo-classical economic beliefs that are based
upon false assumptions. Like all cults, it has many followers who have great
faith in its pronouncements even when those pronouncements are clear
evidence of false logic and disturbed rationality. In this article, we will
take a look at various forms of human thought bias and irrationality which
are arguably manifest in the way the Federal Reserve thinks and operates.
I was annoyed and dismayed but not unduly surprised when I came across an
article claiming that, despite the events of 2008, neo-classical theory
still dominates economics courses in UK universities2. We cannot expect
professors to change their teaching and thinking overnight, but surely six
years after the global financial crisis (GFC) which the theory’s models
failed to predict - even though it was something which appeared inevitable
to me and to a small band of others - it’s time to at least look at
different ways of understanding the economy.
Even more alarming is that the US Federal Reserve seems to be trapped on the
same dogmatic path. The conclusions from its latest Federal Open Market
Committee meeting3 are that its QE money-creation policy is working, despite
economic indicators such as trade and employment suggesting otherwise.
The issue is that neo-classical economics has always made certain
assumptions in order to model how we use money. The publisher and editor of
the excellent BOOM Finance and Economics website suggests the modern form of
this theory is based on three false assumptions:
1. The study of economics is an ‘ethics free zone’;
2. Mankind tends to make rational decisions;
3. Banks, debt and money can be excluded from any analysis of the economy.
Yet, if you ask anyone who is not an economist their opinion on these three
assumptions, it is likely they will immediately tell you that being ethical
in life is very important and that ethical considerations are especially
important in making decisions.
They may also tell you that most human beings are obviously irrational (a
brief look at the history books will confirm this). Finally, they will tell
you that banks, money and debt are the most important things to watch in an
Common Human Faults
I would add some more human characteristics to this:
1. That humans also tend to become emotionally committed to their poor
decisions (even when such decisions are obviously faulty). They cling to
their (unrealized) losses while irrationally continuing to hope for gains.
This is an aspect of Daniel Kahneman’s Prospect Theory - the “triumph of
hope over adversity” - (Kahneman was awarded the Nobel Prize in Economics
2002 for his work in defining this particular cognitive bias). The Fed’s
Cult has most of us buying into the hope that they’re doing the right thing
on this basis.
2. Humans tend towards using only induction as their preferred method of
logical inference without an intuitive understanding or practical experience
of the two other means of logical inference - abduction (“Sherlock Holmes’
elementary logic”) and deduction. A tendency towards only using induction
generates beliefs in broad correlations without differentiating causations
(one of the main bases of the Freakonomics books4).
3. When confronted with two conflicting views of reality, most human beings
tend to react defensively to defend the view that most closely resembles
their own. They exhibit fear, anxiety and possibly aggression - this
reaction is termed cognitive dissonance. Most humans have an inherent
inability to consider two conflicting views of reality without experiencing
internal conflict. This helps the Fed’s Cult to endure.
The founder of the post-WWII economic structure, John Maynard Keynes,
acknowledged the undue impact people, such as those in charge at the Fed,
have on our lives:
“The ideas of economists and political philosophers, both when they are
right and when they are wrong, are more powerful than is commonly
understood. Indeed the world is ruled by little else. Practical men, who
believe themselves to be quite exempt from any intellectual influence, are
usually the slaves of some defunct economist. Madmen in authority, who hear
voices in the air, are distilling their frenzy from some academic scribbler
of a few years back. I am sure that the power of vested interests is vastly
exaggerated compared with the gradual encroachment of ideas.”
The editor and publisher of BOOM highlights the need to
“incorporate demonstrations of operational decision making by competent
professionals who are constantly mindful of the ethical aspect of their
decisions and the immediate and long-term consequences. This process can be
loosely described as ‘breaking down the silos’ and could also occur within
certain professions where silos exist intra-professionally.”
Does that sound like the Fed? Growing up in academic ivory towers in a
broken belief system like economics or in an institution like the Fed
encourages silos; hence the Fed has a cult built around the egocentricity
and hubris of its modern day leaders. For many years after they almost
destroyed the global economy by orchestrating the excess of the 1920s and
1930s, central bankers were social and economic pariahs with limited power
and no prestige - nobody (not even themselves) took them seriously and
consequently they had much less power to do harm.
Definition of Hubris5
Hubris (also hybris, from ancient Greek), means extreme pride or
arrogance. Hubris often indicates a loss of contact with reality and an
overestimation of one’s own competence, accomplishments or capabilities,
especially when the person exhibiting it is in a position of power. The
adjectival form of the noun hubris is “hubristic”.
This tendency is commonly found in persons who have achieved power. “I am
here - therefore, ipso facto, I must be best placed to make these
decisions.” Hubris often indicates a loss of contact with reality and an
overestimation of one’s own competence. It begets certainty and inductive
reasoning. History is replete with examples of intelligent and, in some
cases, highly competent, capable individuals whose climb up and conquest of
the greasy pole imbued them with such hubris that it blinded them to ethics
To be continued…
1 http://www.investopedia .com/terms/n/neoclassical.asp
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