Friday, January 16, 2009

It's a Mad World, After All

Way back when I was crazier than I am now but believed I was normal, I was a financial journalist. I worked in New Zealand and Australia and published three books. Two of them challenged the conventional wisdom of the day, namely that rational self-interest governs all individual decisions regarding money, and that the marketplace is the collective expression of an infinite number of common-sense decisions at work.

Needless to say, I was a voice in the wilderness.

Ten years ago, following my diagnosis, I started writing on my illness. Here, no one was trying to pretend they were normal. I was crazy covering crazy. I felt right at home. So much so that I could pass for normal, even when I told people I was crazy.

I think I was a financial journalist for a full year before I realized that a balance sheet and a profit and loss statement were two different things. To compensate for my obvious deficits, I developed an acute sense of logic.

Wait a second, I said to myself one day. Here, we have economists - nerdy mathematician types - trying to predict human behavior? Nuh-uh, I thought. We're talking psychology here, a discipline based on the proposition that people act irrationally, even against their obvious best interests.

As if to prove my point, one day I flipped out and quit my job on a daily newspaper. The rest of my time in Australia I was (rationally) treated as radioactive.

All you need to do is spend a day in a mall to see that the real world behaves far differently that the one imagined by PhD economists. The entire marketing and advertising industry recognizes this. Their practitioners work on the principle that consumers can be manipulated into making spectacularly irrational choices. If you don't believe me, take a look at all the SUVs on the road.

Conversely, marketers and advertisers are smart enough to know that consumers can make them look spectacularly stupid. That just when you think you have buyers all figured out, they will come at you with something totally out of left field, such as refusing to purchase safari suits, even at steep discounts. Imagine.

Needless to say, the advertising industry employs psychologists. People who know what dopamine can do to the brain, not to mention how our irrational fears and desires and impulses drive our decisions.

If only economists and financiers could be so smart.

In a New York Times piece published yesterday, op-ed columnist David Brooks finally 'fessed up. According to the old way of thinking: "The classical models presumed a certain sort of orderly human makeup. Inside each person, reason rides the passions the way a rider sits atop a horse."

More: "People respond in pretty straightforward ways to incentives. The invisible hand forms a spontaneous, dynamic order. Economic behavior can be accurately predicted through elegant models."

A funny thing happened on the way to 2009 - a complete financial-economic meltdown, an event that classical economics could not predict, much less explain. According to Brooks:

"Reason is not like a rider atop a horse. Instead, each person’s mind contains a panoply of instincts, strategies, intuitions, emotions, memories and habits, which vie for supremacy. An irregular, idiosyncratic and largely unconscious process determines which of these internal players gets to control behavior at any instant."

It's a crazy world, after all. We crazy people had it right, all along.

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