As one of the very few political science/public policy experts analyzing investments, I try to take note of situations reflecting concepts from these fields. As regular readers know, it is not a matter of being smarter than everyone else. Far from it. I search constantly for information, even from unlikely sources. A principle here at "A Dash" is that looking at a problem from differing perspectives often suggests wildly different results.
Prediction Requires Understanding
To predict behavior you first must understand it. Sometimes examples are the best place to start, so please consider these.
The 2008 Crisis
At the time of the 2008 post-Lehman financial crisis, there was an active public policy debate. Here are some key quotations:
Before going to the Hill, I briefed Obama and McCain....I overcommunicated with both candidates because I understood that if either of them made...any part of the crisis into a campaign issue to win political popularity, we were dead. I told them that the Fed had to take action and made the point that we were protecting taxpayers---not bailing out shareholders. Again I asked both of them not to characterize this as a bailout.
and later in time --
Obama was creeping ahead, and McCain was trying to distance himself from the Bush White House. He was slinging populist rhetoric on the campaign trail, excoriating Wall Street, talking about protecting taxpayers, and using the word bailout.
So who was the source of these statements? Barney Frank? Harry Reid? Nancy Pelosi? Ben Bernanke?
Actually it was Bush Administration Treasury Secretary Hank Paulson.
Yes, I am talking about a pillar of the conservative establishment, a former Goldman Sachs CEO, and someone who, when he began his service, would never have guessed that he would wind up leading the TARP initiative, as well as other rescue attempts.
And by the way, neither would his President, George W. Bush, who began the crisis in full opposition to anything that could be called a "bailout."
The interesting question is how could this possibly happen?
The Classic Example
Consider what might be the most important decision by anyone -- Truman's decision to drop the atomic bomb. You might expect that this would require a careful and rational analysis, exhaustive debate, and a soul-searching decision.
The facts were quite different.
- Truman was an unlikely president, someone of modest success and qualifications who was ready to retire in his 50's. A series of improbable events placed him in the Senate, and later as FDR's Vice-President.
- Truman had some good instincts, strong values, and some skill at military leadership.
- Many historians and political scientists use him as an example of someone who"grew into the job."
- Truman never really questioned the use of the A-bomb, nor did he second-guess himself later.
- Everyone on his team, as the decision process moved forward, treated these events as part of a plan that had already been set in place. The bomb was invented so that it could be used to end a war without further risk to US troops. There were some objectors, but they did not have significant advisory roles.
This was a classic example of what is called a "non-decision." It is something that happens when you do not act, in this case to deflect the existing course of policy. The key points to note are the overwhelming consensus about the purpose of the Manhattan Project and the portrayal of risk (the loss of millions of US and Japanese lives in an invasion of Japan).
The implication, strongly supported by the lengthy and authoritative Truman biography, is that you or I would have made acquiesced in the same way had we been in Truman's shoes.
Some Useful Applications
There are two immediately useful applications for these principles. Both are crucial for investors.
Monetary policy is the subject of both policy debate and prediction. Some have suggested the appointment of non-traditional candidates to the Fed. The suggestions, perhaps whimsical, have included housewives, economic bloggers who are not economists, and vocal Fed critics. Would this make any difference in Fed policy?
No.
I already knew the answer, but at the Kauffman Foundation gathering of economic bloggers I asked Bob McTeer (former Dallas Fed President and a featured source who combines intelligence, wisdom, and experience) what would happen in the case of a non-traditional appointment. I mentioned some of the examples.
Since I did not really put Bob "on the record" I will merely summarize his viewpoint and allow him to chime in if he wishes. He first observed that the Fed staff was extremely talented and able and had access to the very best information. It was difficult to improve on their findings. I nudged this a little, asking what about those who disagreed with the staff approach. He said that dissent was possible, but that arguments had little effect when not placed in the context of the general analytic framework.
In political science and sociology these effects are referred to as recruitment and socialization. An organization generally recruits people whose values and approach is consistent with organizational norms. New members go through a process of socialization where they learn what sort of argument is effective. It is completely predictable behavior for the Fed, Morgan Stanley, BP, or any other organization. Investors would do better if they understood social science principles.
Fiscal policy is the subject of debate between groups that I will loosely characterize as Keynesians (new-, post-, neo- or whatever) and non-Keynesians (Austrian economists or whatever variant). In a short article I cannot avoid some generalizations, so let me just say that the latter group thinks we should aggressively address deficits and let the chips fall where they may. The Keynesians embrace and accept debt as a road to economic recovery when the economy is threatened.
Since real leaders, especially elected leaders, are not willing to attempt the Austrian experiment, the actual decision process can easily be predicted. Any skeptics should go back and review the Hank Paulson quotations above, and note the focus on "saving the system."
Investment Conclusion
I am going to emphasize once again that this article is not about which monetary policy or fiscal policy is correct. I am trying to explain how to predict government actions.
It is descriptive, not prescriptive. Many pundits who have strong beliefs are not able to step away to analyze what will happen, and the likely investment implications.
With that in mind, here are some predictions:
On the monetary policy front, the Fed (and other central banks) remain focused on economic weakness. The policy statements are clear and should be believed. They are more fearful of deflation than inflation.
On the fiscal policy front governments are well aware of the dilemma. The "balanced budget" side is so easy to explain and so intuitive for the tea-party crowd. Meanwhile, leaders in the US and abroad are well-schooled in the implications of fiscal tightening in a fragile economy. They have all heard about 1933.
Simply put, they are not listening to the siren song of the Austrian economic school. Meanwhile, the individual investor is bombarded with commentary from "self-taught" Austrian economists. (I am still trying to figure out how one gets official credentials!)
My Summary
It is fine to believe in Austrian Economics, or Ron Paul, or Milton Friedman, or George Bush, or Hank Paulson, or even Jim Bunning. It is a free country and we should all appreciate and exercise that freedom.
In investing, you need to put your political opinions aside and focus on prediction. That is where I am trying to help.
