How To Solve the Economic Crisis → Washingtons Blog
How To Solve the Economic Crisis - Washingtons Blog

Thursday, February 26, 2009

How To Solve the Economic Crisis

The Economics of Trust

A 2005 letter in premier scientific journal Nature reviews 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, Ph.D. wrote in October:
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).
And two professors of finance write:

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.
Americans clearly don't trust the bankers and the financial bigwigs.

Indeed, as leading economists have pointed out, the big financial institutions don't trust each other, because they know that all of the other companies might have hidden their problems or gamed their books (see this, for example). See also this.

There's Nothing We Can Do!

The main problem we are facing is that our leaders are pretending that there is not much they can do to fix the economic crisis.

But the truth is that the powers-that-be are getting too many perks from the current system to really fix it.

Let's look at an analogy. A gang member keeps on getting thrown into jail for selling cocaine. The court-appointed psychiatrist says "why don't you stop?". The gangbanger says "I don't know how to stop". In reality, the gentleman is making money dealing cocaine, and maybe getting a sense of safety and community in belonging to a gang.

Or here's an analogy closer to home for me. My very young daughter frequently throw tantrums. When my wife and I tell her to stop screaming, she says "I don't know how to stop." We tell her she just has to decide to stop screaming, and then the screaming will stop. She repeats "No, I don't know how to stop!" and keeps on screaming. Obviously, the pay-off of getting our attention (and getting our goat) makes it worthwhile for her to keep on screaming.

Similarly, Bernanke, Geithner, Summers, Barney Frank, Chris Dodd, Obama and the rest of the gang pretend they don't know how to fix the economy, because, in reality, their corporate funders don't want it to be fixed.

How Can We Fix the Economy?

Given that there is a total breakdown in trust, our leaders can only help to turn the economy around if they admit that they've blown it.

They have to admit that:

  • The entire modern financial system has been built on a house of cards (see this and this)
  • Our economy cannot prosper without a strong manufacturing base, and without services which actually help people (instead of doing othing but shuffling money around from one financial desk to another)
  • They allowed far too much leverage in the system and far too much fractional reserve banking
  • Throwing more money at the too-big-to-fail companies will not help anything, and that it is the American people who need relief
  • The Fed can't simply blow one bubble after another to rescue the economy
  • Things have been shrouded in too much secrecy, and that we need radical openness of the financial system

If our leaders admitted these things, trust would be restored, and we could get back to work and restore our economy.

Can't be done! Not politically realistic!

Sure, the cocaine dealer and my little girl say the same thing.

What it means is that they don't want to change because they would lose their perks.

Note 1: Americans no longer trust the politicians, the justice system, their ability to obtain liberty, or the media. Americans know that the boys lied us into war in Iraq (which has bankrupted us to the tune of $3-5 trillion dollars), imported communist Soviet Union torture techniques and then said "we don't torture", spied on Americans (even before 9/11 ... confirmed here and here) while saying "we don't spy", and covered up the facts about 9/11 (even the 9/11 Commission thinks there was a coverup ... see also this).

Therefore, I passionately believe that a new honesty has to take place among our government and corporate institutions, and that the truth about these crimes has to be fully revealed before our economy will fully recover.

Unrealistic? Idealistic? Not feasible? Okay, but then trust will not be restored and the depression might last decades, with widespread violence the possible result.

Note 2: It's obvious that many politicians think they have to do something about the economic crisis. And so they throw trillions of dollars into bailouts, "loans" and other schemes which are actually making the problem worse.

This is the flip side to the problem of pretending you can't do anything. Doing something just to be doing something isn't very smart - especially when restoring trust would cost trillions less and would be much more effective.


  1. All the crimes of the previous administration you listed in this piece are true and have been known about for years and yet when the democrats took control in 06 they did not go after them. Carl Rove just refuses to obey a subpoena 3 times now and nothing happens, The intelligence committee knew about the torture techniques that were being used and said nothing (secrecy acts) BS. Wire tapping same thing, the Iraq war same thing. So of course they rob us and the rest of the world blind and cause another depression. Nothing we can say or do along standard lines will works , they just ignore us. Many forecasters are predicting that we will go to the streets this summer and you can see it happening all over the world. We will have to build a whole new toilet. This one won't flush anymore

  2. This is an excellent prescription for fixing the mess. Unfortunately it doesn't appear that Messrs Summers and Geithner are paying attention. They are just shoveling more money to the people who betrayed our trust with no real reform of the system itself.

    The best we can hope for is that after the Obama team fails due to their wimpy approach, they will get religion and turn things around. Of course, by that time, the political capitol will have been spent and the Relimbaughicans will obstruct any real reform.

  3. Thanks for this- I just sent the link to this article and the following message to Obama- not that he cares or will notice necessarily, but I think as Citizens we need to talk to our public servants, as well as tell each other about their crimes. Also, a real human being may read it, click the links and think. And now I've posted it here for posterity:

    It's clear that Obama does support some measures that serve the public interest, i.e. renewable energy/infrastructure investment, increasing funding for education, health care and broadband access raising taxes on the filthy rich who pay an average income tax rate of 17%. However, it's becoming increasingly clear to more and more people who voted for "change" that Obama aims to protect the corrupt Establishment that profits from war and social control, i.e. stacking his cabinet with hawks and corporate/Establishment insiders instead of people promoting a progressive agenda and 'change', using the Bush Administration's claim of "state secrets", being uninterested investigating and prosecuting illegal domestic spying, torture, rendition, Iraq War and 9/11 lies, bailing out the bankers and investors who caused the economic meltdown instead of working to reform our financial system that rewards an unproductive elite investor class at the expense of the general welfare, etc. Sooner or later, the People of the U.S. and the world and the nature of economics will result in growth, but minds once expanded don't shrink. People are increasingly turning to the Web for information and the spin, lies and lack of integrity of the Republocrats and corporate media are becoming less effective in molding public opinion.

    If he wants to get reelected and leave a positive legacy, unlike Bush, Obama would do well to heed the lessons about the importance of trust outlined in this article by George Washington, and stop trying to shore up a corrupt socio-politico-economic order:

    How To Solve the Economic Crisis

    Free enterprise is a good thing, but markets rigged by politically powerful people in their own short-sighted perceived self interest are not free markets.

    Obama should consider the economic theory of Silvio Gesell; in 1933 in Worgl, Austria a small tax on money increased its circulation by 14 times, resulting in full employment, long term sustainable investment, no inflation and fully funded public works projects. It's the bankers who changed the Biblical definition of usury from "interest" to "excessive interest", and claim that 20-30% interest on debt-not-money-backed credit card debt is not fraud or "excessive".

    The Wörgl Currency and Demurrage

    The NATURAL ECONOMIC ORDER by Silvio Gesell

  4. What caused this depression is the same thing that causes all depressons (a.k.a. recessions) which don't have an obvious destructive event such as war or natural disaster: artificial inlfation of the money supply. Of which occurs through fractional reserve banking and/or an increase in fiat money, i.e., through fraudulent banking and/or through counterfeiting.

    The reason why is because all prices are determined by supply and demand, including the interest rate, which is the price on loans. By artificially increasing the money supply by means of fraud and/or counterfeiting, this lowers the price of the interest rate. It thereby falsely gives the appearance of more savings existing (i.e., more saved wealth available to loan) than is actually the case. More to the point, it makes business projects that otherwise would not have been undertaken seem ex ante to be profitable, but which are later found not to be viable. Hence, by lowering the interest rate below the natural rate, it causes malinvestments, particularly clustered in the area of capital goods (since the only way to grow an economy is through an increase in capital goods, i.e., those goods which aren't consumed for their own sake, but are used to make the consumer goods people do directly use).

    As well, the first spenders of the fiat/fractional reserve money (i.e., the government and its insider-connected elites who create it on fiat) get the benefit of obtaining actual goods and services by spending money that was, in effect, created out of essentially nothing. That is, the government and its favored elites who create the fiat/fractional reserve money get actual goods and services essentially for free (i.e., for the cost of typing a few numbers into a computer terminal, writing a few numbers in a ledger, or printing up some paper). Whereas the rest of the economy is saddled with a devauled currency. Moreover, actual goods and services in the economy are being funneled from genuine value-producers into a parasitical sector of society, thereby making society as a whole poorer and less productive than it would have been without this parasitical drain.

    Hence, in addition to causing the destructive boom-bust cycle in the economy, a fiat/fractional reserve currency also acts as an obfuscated tax, although a particularly pernicious tax.

    For more on this, see:

    America's Great Depression, Prof. Murray N. Rothbard (Auburn, Alabama: The Ludwig von Mises Institute, fifth edition, 2000; originally published 1963)

    The above book concerns how governments create depressions/recessions through credit expansion (i.e., fractional reserve banking and/or fiat currency).

    See also:

    "Against Fiduciary Media," Prof. Hans-Hermann Hoppe with Profs. Jörg Guido Hülsmann and Walter Block, Quarterly Journal of Austrian Economics, Vol. 1, No. 1 (1998), pp. 19-50

    I should also point out that plank No. 5 of Karl Marx and Friedrich Engels's Communist Manifesto is "Centralisation of credit in the hands of the State, by means of a national bank with State capital and an exclusive monopoly." (See Manifesto of the Communist Party by Marx and Engels, English edition of 1888 .)

    For the history on how the "capitalist" (i.e., mercantilist) elite in the U.S. bankrolled Communism as well as National Socialism, see the below scholarly books by libertarian Antony C. Sutton, Ph.D.:

    Wall Street and the Bolshevik Revolution, Antony C. Sutton, Ph.D. (New Rochelle, N.Y.: Arlington House Publishers, 1974)

    (Note: Chapter I of the above book refers to a 1911 St. Louis Post-Dispatch cartoon illustration by Robert Minor. This can be viewed here: .)

    Wall Street and the Rise of Hitler, Antony C. Sutton, Ph.D. (Suffolk, England: Bloomfield Books, 1976)

    The Best Enemy Money Can Buy, Antony C. Sutton, Ph.D. (Billings, M.T.: Liberty House Press, 1986)

    See also:

    "Thyssen Funds Found in U.S.," International News Service (INS), July 31, 1941

    Vesting Order Number 248, Federal Register, November 7, 1942

    "Bush-Nazi Link Confirmed," John Buchanan, New Hampshire Gazette, Vol. 248, No. 1, October 10, 2003

    "'Bush-Nazi Dealings Continued Until 1951'--Federal Documents," John Buchanan and Stacey Michael, New Hampshire Gazette, Vol. 248, No. 3, November 7, 2003

    "How Bush's grandfather helped Hitler's rise to power," Ben Aris and Duncan Campbell, Guardian (U.K.), September 25, 2004,12271,1312540,00.html

    "How the Bush family made its fortune from the Nazis," Attorney John Loftus, former U.S. Department of Justice Nazi War Crimes prosecutor and current President of the Florida Holocaust Museum, September 27, 2000


    I also recommend that everyone see the below reading list:

    "Recommended Reading Concerning Political and Economic Theory," September 30, 2005

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  6. I think you've identified a necessary, but not sufficient, condition for recovery. Admitting these failures of trust isn't enough though, the political will, the economic means, and the social desire to do something about the circumstances you identify has to exist.

    The factions that benefit from the existing economic order have spent the last thirty years and untold resources convincing the electorate of a set of delusions that give it incentive to vote against it's own self interest.

    They've been so successful that many of the initial propagators of this fantasy now believe their own crap. When a belief system reaches this stage it's usually unsalvageable. The deluded participants are consigned to a fate of following the dictates of their flawed belief systems until it collapses from it's own weight.

    Those who engineered these delusions, and continue to profit from them, have no interest in their correction. They'll see the system go down before they'll relinquish the privilege that the flawed order insures for them, or by the time they recognize their folly the social, economic, and political resources to reverse the decline will have been spent.

    The issues involved are sufficiently complex, varied, and subject to legitimate debate that they are easily distorted towards the ends of those who desire that the confusion continue, or who welcome the chaos and collapse of the system for the opportunity it provides to replace it with something of their own, usually much darker, design.

    So it has always been, and so it will continue to be.


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