We Cannot Separate Economics and Politics. And Those Who Speak Out Against Bad Policy Are Helping the Economy ... And Our Individual Investments

Some people criticize the injection of politics into economic discussions.

But economic historians tell us that economists used to understand and accept that economics is wholly interrelated with politics, and that politics affects our economy. They note that modern economists have artificially tried to somehow separate the two, like Descartes tried to separate the mind from the body.

Indeed, the father of modern economics - Adam Smith - talked a lot about politics in relation to economics.

If mainstream ("neoclassical") economists think that politics is an irrelevant and separate topic, it may be because they are using wholly discredited models or that "it is difficult to get a man to understand something, when his salary depends upon his not understanding it."

In the real world, political decisions determine who gets bailed out and who doesn't, who stays afloat and who goes under, who gets rewarded and who gets prosecuted (and if prosecuted, who gets hit hard and who gets off with a slap on the wrist ... or a slap on the back). As such, it should be obvious that we cannot discuss our economy or even investing decisions without addressing politics.

Another example of the intersection of politics and the economy is military policy. America's military policy is directly connected with the economy, and is indirectly connected with our individual investments.

Specifically:

1. War is bad for the economy. The multi-trillion dollar price tag for the wars in Iraq and elsewhere are bankrupting our country. Moreover, war always causes inflation, and thus decreases the value of our money.
   
2. We were lied into war
3. The lies are continuing
4. The state of emergency we've been living under for the past 10 years has interfered with the free markets
   
5. It is much harder to make investment decisions when we are not in a free market
   
6. Therefore, if enough of us speak out against the ongoing lies, we may have some chance of helping the economy and reinstating some semblance of a free market ... which would help increase the value of our money, and make investing simpler

As I noted last November, the lack of trust by the American people in the government's military decisions is harming the economy:

Trust in Government is Necessary for a Stable Economy

A 2005 letter in premier scientific journal Nature reviewed the research on trust and economics:

Trust ... plays a key role in economic exchange and politics. In the absence of trust among trading partners, market transactions break down. In the absence of trust in a country's institutions and leaders, political legitimacy breaks down. Much recent evidence indicates that trust contributes to economic, political and social success.

Forbes wrote an article in 2006 entitled "The Economics of Trust". The article summarizes the importance of trust in creating a healthy economy:

Imagine going to the corner store to buy a carton of milk, only to find that the refrigerator is locked. When you've persuaded the shopkeeper to retrieve the milk, you then end up arguing over whether you're going to hand the money over first, or whether he is going to hand over the milk. Finally you manage to arrange an elaborate simultaneous exchange. A little taste of life in a world without trust--now imagine trying to arrange a mortgage.

Being able to trust people might seem like a pleasant luxury, but economists are starting to believe that it's rather more important than that. Trust is about more than whether you can leave your house unlocked; it is responsible for the difference between the richest countries and the poorest.

"If you take a broad enough definition of trust, then it would explain basically all the difference between the per capita income of the United States and Somalia," ventures Steve Knack, a senior economist at the World Bank who has been studying the economics of trust for over a decade. That suggests that trust is worth $12.4 trillion dollars a year to the U.S., which, in case you are wondering, is 99.5% of this country's income. ***

Above all, trust enables people to do business with each other. Doing business is what creates wealth. ***

Economists distinguish between the personal, informal trust that comes from being friendly with your neighbors and the impersonal, institutionalized trust that lets you give your credit card number out over the Internet.

Similarly, market psychologists Richard L. Peterson M.D. and Frank Murtha, PhD noted:

Trust is the oil in the engine of capitalism, without it, the engine seizes up.

Confidence is like the gasoline, without it the machine won't move.

Trust is gone: there is no longer trust between counterparties in the financial system. Furthermore, confidence is at a low. Investors have lost their confidence in the ability of shares to provide decent returns (since they haven't).

Two professors of finance pointed out:

The drop in trust, we believe, is a major factor behind the deteriorating economic conditions. To demonstrate its importance, we launched the Chicago Booth/Kellogg School Financial Trust Index. Our first set of data—based on interviews conducted at the end of December 2008—shows that between September and December, 52 percent of Americans lost trust in the banks. Similarly, 65 percent lost trust in the stock market. A BBB/Gallup poll that surveyed a similar sample of Americans last April confirms this dramatic drop. At that time, 42 percent of Americans trusted financial institutions, versus 34 percent in our survey today, while 53 percent said they trusted U.S. companies, versus just 12 percent today.

As trust declines, so does Americans’ willingness to invest their money in the financial system. Our data show that trust in the stock market affects people’s intention to buy stocks, even after accounting for expectations of future stock-market performance. Similarly, a person’s trust in banks predicts the likelihood that he will make a run on his bank in a moment of crisis: 25 percent of those who don’t trust banks withdrew their deposits and stored them as cash last fall, compared with only 3 percent of those who said they still trusted the banks. Thus, trust in financial institutions is a key factor for the smooth functioning of capital markets and, by extension, the economy. Changes in trust matter.

They quote a Nobel laureate economist on the subject:

“Virtually every commercial transaction has within itself an element of trust,” writes economist Kenneth Arrow, a Nobel laureate. When we deposit money in a bank, we trust that it’s safe. When a company orders goods, it trusts its counterpart to deliver them in good faith. Trust facilitates transactions because it saves the costs of monitoring and screening; it is an essential lubricant that greases the wheels of the economic system.

And a distinguished international group of economists (Giancarlo Corsetti, Michael P. Devereux, Luigi Guiso, John Hassler, Gilles Saint-Paul, Hans-Werner Sinn, Jan-Egbert Sturm and Xavier Vives) wrote:

Public distrust of bankers and financial markets has risen dramatically with the financial crisis. This column argues that this loss of trust in the financial system played a critical role in the collapse of economic activity that followed. To undo the damage, financial regulation needs to focus on restoring that trust.

They noted:

Trust is crucial in many transactions and certainly in those involving financial exchanges. The massive drop in trust associated with this crisis will therefore have important implications for the future of financial markets. Data show that in the late 1970s, the percentage of people who reported having full trust in banks, brokers, mutual funds or the stock market was around 40%; it had sunk to around 30% just before the crisis hit, and collapsed to barely 5% afterwards. It is now even lower than the trust people have in other people (randomly selected of course).

Time Magazine pointed out:

Traditionally, gold has been a store of value when citizens do not trust their government politically or economically.

In other words, the government's political actions affect investments, such as gold, and thus the broader economy.

Trust Is At An All-Time Low

Unfortunately, the public's trust in government as a whole (and see this and this), the justice system, bankers, and the corporate media are at all-time lows.

Why?

Partly because the government has been repeatedly caught lying.

The government repeatedly said about the subprime crisis, banking crisis, debt crisis, mortgage crisis, and other economic crises:

• "It's contained"

• "We've got it under control"

and

• "We're going to fix it"

It wasn't, and they didn't ... and so people have lost trust in the government.

But it's not just the economy. The government also got caught making false claims that:

• Iraq had weapons of mass destruction, had a hand in 9/11 (and see this) and carried out the the anthrax attacks

• 9/11 wasn't foreseeable

• That the government doesn't spy on Americans (it did even before 9/11), Americans don't torture, etc.

It is basic human nature that - if you catch someone lying about one topic - you will tend to doubt the truth of what he is saying in other areas as well.

So Americans' loss of trust in the government's political actions have also undermined their trust in the government's statements and actions in the economic field.

But there's another important reason for Americans' lack of trust in our government and our economy: the failure to prosecute the criminals.

Prosecuting the Criminals and Launching REAL Investigations Is Necessary to Restore Trust

One of the leading business schools in America - the Wharton School of Business - has written an essay on the psychological causes and solutions to the economic crisis. Wharton points out that restoring trust is the key to recovery, and that trust cannot be restored until wrongdoers are held accountable:

According to David M. Sachs, a training and supervision analyst at the Psychoanalytic Center of Philadelphia, the crisis today is not one of confidence, but one of trust. "Abusive financial practices were unchecked by personal moral controls that prohibit individual criminal behavior, as in the case of [Bernard] Madoff, and by complex financial manipulations, as in the case of AIG." The public, expecting to be protected from such abuse, has suffered a trauma of loss similar to that after 9/11. "Normal expectations of what is safe and dependable were abruptly shattered," Sachs noted. "As is typical of post-traumatic states, planning for the future could not be based on old assumptions about what is safe and what is dangerous. A radical reversal of how to be gratified occurred."

People now feel more gratified saving money than spending it, Sachs suggested. They have trouble trusting promises from the government because they feel the government has let them down.

He framed his argument with a fictional patient named Betty Q. Public, a librarian with two teenage children and a husband, John, who had recently lost his job. "She felt betrayed because she and her husband had invested conservatively and were double-crossed by dishonest, greedy businessmen, and now she distrusted the government that had failed to protect them from corporate dishonesty. Not only that, but she had little trust in things turning around soon enough to enable her and her husband to accomplish their previous goals.

"By no means a sophisticated economist, she knew ... that some people had become fantastically wealthy by misusing other people's money -- hers included," Sachs said. "In short, John and Betty had done everything right and were being punished, while the dishonest people were going unpunished."

Helping an individual recover from a traumatic experience provides a useful analogy for understanding how to help the economy recover from its own traumatic experience, Sachs pointed out. The public will need to "hold the perpetrators of the economic disaster responsible and take what actions they can to prevent them from harming the economy again." In addition, the public will have to see proof that government and business leaders can behave responsibly before they will trust them again, he argued.

Note that Sachs urges "hold[ing] the perpetrators of the economic disaster responsible." In other words, just "looking forward" and promising to do things differently isn't enough.

Economists such as William Black and James Galbraith and Nobel prize winning economists Joseph Stiglitz and George Akerlof agree.

Indeed, polls show that:

• Americans want investigations into torture and wireless wiretapping
  

• Most Americans believe that the Iraq war was a mistake. At least half of all Americans wanted Congress to impeach President Bush if he lied about the Iraq war

• Hundreds of millions of Americans think that there was a cover up about 9/11, and want a thorough investigation

• Americans want those who committed financial fraud to be prosecuted

Remember, distrust in the political actions of government officials undermines the economy as well. Therefore, the economy will not recover until the economic criminals are prosecuted, and there are real investigations into 9/11 (even the 9/11 Commissioners themselves think there should be more investigation: see this and this), the Iraq war, torture, spying on Americans and other government failures.

So people who criticize the government's lies, and call for the prosecutions of those who made the misstatements, are actually working towards stabilizing our economy, and making our investment decisions a little easier.