The psychology of real

Today I was talking about the economy with someone who I respect a lot.  She said that we still don’t know how much of what’s going on in the economy is real and how much is psychology.

I respectfully disagreed.  What strikes me most about this economic crisis is that what’s psychology is real.  There’s no distinction any more.  Sentiments drive markets as much or more than what’s “real.”  And 6 months worth of sentiments might create real, irreversible hardships.

Her broader point, my rebuttal notwithstanding, is that people have short memories, and if psychology does drive markets then things have the potential to get better very quickly.  A new President who has a successful first 100 days could set a good tone, and by the second quarter we could see the first glimpse of things no longer getting worse.

My worry is that enough real hardship will come from the psychology of fear we’ve lived through since October that a shift in mindset won’t be enough to avoid a protracted economic downturn.

Either way, it feels like we’re navigating between 2-3 years of things being bad and a Lost Decade a la Japan in the 90s.

So here’s the question if you’re in the nonprofit sector: is your current business plan, at a minimum, premised on things being bad for 24-36 months?  And what if things are bad for a lot longer than that?  Are you ready?  And if not, what can you do to make yourself ready?

And if yours is the kind of nonprofit organization where the best and the brightest don’t spend much (or any) time thinking about the revenues side of the equation, don’t you think now is the perfect time to change that?

3 thoughts on “The psychology of real

  1. One thing to keep in mind Sasha is that the economy and the markets are linked but not the same. Psychology has always driven markets and effected the economy. However, the impact of psychology on the markets is much more dramatic than on the economy because when you feel down you can sell your stocks and then buy them back three days later when you’re feeling optimistic again. But economic activity moves slower. You can’t quit your job on Wednesday and take it back on Friday as your mood shifts.

    You might be interested in a book by George Soros called The Alchemy of Finance. The core issue in the book is what Soros calls “reflexivity”. Until that book came out, most people only looked at how the economy affected markets. Soros’ point was that markets also affect the economy. I think this past October was the most dramatic example in history of markets affecting the economy.

  2. Above comment is true, but still one should remember that a lot of people would like to quit there job on wednesday and take it back on friday.

    Their solution is simple; they call in sick on wednesday and show up ‘better’ on friday.

    So Sasha is right in the fact that the same psychology that drives markets in the end drives the economy as well.

    25 years ago I was in London to learn more on futures markets. One of the the specialists said that when we would be back on monday our clients would ask: “Why is the price of sugar moving up..?”.
    He suggested we would answer with: “You are asking two questions.
    The first one is; “Is the price of sugar going up?” the answer is yes…..
    The second question is; “Why?”.
    The answer is that many philosophers have been thinking about ‘why’ and have not figured out the final answer………
    The guy worked at Merrill Lynch, was very successful, and had finished his masters in psychology. More often than not I feel he was right…..

  3. Sean, thanks for your comments. I haven’t read The Alchemy of Finance but I’ll put it on my list.

    What I find striking is the centrality of credit markets to the functioning of just about everything (real estate, consumer durables, cars, IT spending….) coupled with the complete dismantling of regulation of these markets which has resulted in an exponential increase in complexity and – as we’ve all learned – risk. And 6+ months of frozen credit markets could have impacts on the real economy that will take years to overcome, even for businesses whose core business model and economics are sound.

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