9/12/2011

Discipline or Bust

Does the aggregate level of self discipline within an economy play a role in our economic stability, or more specifically—does it determine the extent to which our economy will be able to recover from a crash? Some leading economists seem to think so—I agree. Dr. Brian Knutson a Stanford Psychologist has published a number of articles that have linked the idea of us receiving a large sum of money, to stimulating the same emotional sensors of the brain that sex and drugs activate. In other words—money and the idea of consumption is a very powerful stimulus. His work is helping financial planners better understand how to consult their clients; how casinos can take advantage of individual’s emotions to increase profit and the like. The idea that emotion affects our financial decisions is nothing new and seems almost common sense, but what if those at the lower income brackets all overspend and refuse to live within their means? Dr. Steven Gjerstand’s (a Nobel Peace Prize recipient) article hypothesizes that excessive consumer debt is the differentiating factor present when our financial markets crash and have a difficult time rebounding. If his hypothesis is correct, we may be in a world of hurt. Remember, Dr. Knutson has linked our response to money as being on the same level as some incredibly powerful stimuli (drugs and sex)—as long as liquidity is available to the undisciplined, consumer debt will continue to grow and increasingly violent market corrections will, hopefully sooner than later, beat us and our government into living within our means. In the mean time, small businesses lack liquidity and in most cases need credit to achieve a scalable system. Only time will tell how markets and regulators will respond, but make no mistake—self discipline is a variable we must reconcile with.

3 comments:

Dr. Tufte said...

Joe: Gjerstand is not the Nobel Prize winner, his co-author Smith is.

This topic touches on some politically incorrect issues.

But, let me jump in with both feet: there's been evidence around for decades that the discount rate is higher for the poor. That's the same discount rate in the NPV formula that goes in the opposite direction of value. It's not clear if a high discount rate makes you poor, or being poor gives you a high discount rate. What is clear is that a high discount rate means that you are less likely to find waiting for long-term investments to pay off acceptable.

Smith won his Nobel Prize for developing the field of experimental economics. Experiments show another disturbing behavior: 1) experienced traders don't create asset price bubbles, but 2) you don't have to introduce very many new, inexperienced, traders into the mix every period for bubbles to start forming.

Joe said...

Dr. Tufte,
I stand corrected! I confused the two when reading about each of them.

Can you comment regarding the amount of consumer debt the poor has and its relation to the economy's ability to recover? I understand what you are saying about the discount rate conundrum--I would very much like your opinion on consumer debt.

Dr. Tufte said...

This is more of a macro. than a man. ec. issue, but here goes.

I don't have problems with how much debt the poor have (or anyone else has).

Yes, this does cause problems for some individuals. And yes, I think some people are not disciplined enough to use debt reasonably. And, if I can get away with being politically incorrect, I think there are people who are not smart enough to understand their debt contracts. I don't think the first group is that large. I think the second group is huge, but I think a lot of that is willful ignorance.

I think there are a lot of big picture ideas that are missed when we talk about debt:

1) How on earth is it possible for companies to loan money to consumers profitably when they have so much difficulty loaning profitably to people who want to make investments? I think we need to blame policy for that (and not just the U.S., it's worse in most other countries).
2) Why do we encourage people through the tax system to shift their debt onto their mortgages? Primary residential real estate is already leveraged, illiquid, and can't be relocated to places where its marginal product is higher. This is the last thing we want people borrowing money for.