How does psychoanalysis explain why euphoria quickly turns into doom mongering in financial markets?
Many economists believe that the global economy is unstable. Global debt has never been so big. As a result, the two major economic blocks (Europe and the US) have, for the last ten years, been getting deeper into trouble. During this same period, China has also seen its private debt, as a percentage of the GDP, double. Are we approaching another debt-driven turning point? For decades, the big question for me has been: what is the origin of a ‘turning point’?
Following my 2016 documentary Boom Bust Boom about Hyman Minsky, people often ask me if I can predict when the next Minsky Moment is coming. A Minsky Moment is the turning point when a period of debt-driven growth shifts to cause the collapse of a financial system. The answer to this question is that we do not know. The billions of players in the global economy make decisions for rational and irrational reasons. People, the media and markets react continuously to each other and that makes the turning point very unpredictable. Of course, instability can continue to increase and as long as everyone thinks it is sustainable, so it can remain unstable for a long time.
The negative effects of storytelling
The economist David Tuckett discusses how perceptions impact behaviour from a psychoanalytic perspective in his interesting book Minding the Markets. Our brains are guided by stories; fantastical stories that do not have to be perfectly ‘true’, because financial instruments are too abstract for that. But these stories sound coherent and fit with what our brains like to hear. They justify our emotions and give us a sense of control; they reduce our sense of insecurity or ambiguity.
This is not really anything new. The Nobel Laureate Robert Schiller has been talking about narrative economics and the epidemic nature of these kinds of stories for years. However, these stories sometimes conflict with our rational thinking. Our rationality can have doubts and construct risks, especially when we are very positive. This is important for making good assessments.
In certain situations, our brain overrides the conflict between positive and negative feelings. Tuckett calls this “divided states”. When we feel good, our brain unconsciously works hard to suppress the alarm bells. Or vice versa: with very negative emotions, our brains suppress positive feelings. Several experiments show that people, if they have a good feeling about something, underestimate the risks more than they would if they had a bad feeling. This is known as affect heuristics. It creates an imbalance between conscious knowledge about the positive aspects and (partially) suppressed knowledge of the risks.
The opposite of unstable divided states is “integrated states”. We can have positive feelings about something that are tempered by their associated risks or other disadvantages. In reality, we make trade-offs in integrated states continually and there is a healthy balance of the benefits and the risks in our conscious knowledge.
However, in the financial world, decisions are often made when the brain is in the unhealthy divided state. Tuckett discovered this following his analysis of and interviews with many experienced investors. The explanation for this is in the specific characteristics of financial markets: volatile and uncertain, abstract and mythical and with no clear distinction between luck and skill.
The problem with divided states is that our ‘love’ for a particular stock or a whole asset class can suddenly turn into ‘hatred’. This happens in particular when investors have developed a particularly positive view, or narrative, around an investment and then negative news breaks that contradicts this narrative. Our brains unconsciously suppress the news and the unbalanced love for the investment remains. This lasts until the news becomes so uncomfortable that the favourable perception changes radically. This change in perception results in emotions of anger and disappointment and so the irrational ‘love’, acquired through rose-tinted glasses, turns into irrational ‘hatred’. Tuckett continually encountered this phenomenon in his research of very experienced investors. He found that investors in a very negative mindset, that is a result of this shift in perspective, are “selling blind”.
We can never know when the turning point will take place, thanks to the invisible divided states of many millions of investors. But Tuckett helps us understand a little better why we can be so blind to massive risks, such as a debt crisis, for so long and why we can shift perceptions suddenly and, consequently, overestimate risk.
Tuckett also gives recommendations; it should be mandatory to provide more transparency about risks. But perhaps even Tuckett is too naive about the powers of our subconscious. After all, we can hardly change people individually. Fortunately, behavioural economics teaches us about all sorts of cognitive tools that can assist us, on the board or at an institutional level so that we do not let our subconscious influence our perception of risks.
However, we have to accept that the timing of a Minsky Moment is fundamentally unpredictable.