bull bear.jpgEconomy Polarizing Political Economy 

Boom Bust Boom

By James H. Nolt

This is my 50th blog article in this weekly series. Here I focus on a new film I saw Tuesday in Manhattan called Boom Bust Boom, now showing. One of the co-directors, Ben Timlett, was there along with two of the people who appeared in the movie, economist L. Randall Wray, and radio host Alan Minsky, son of the late economist, Hyman Minsky, one hero of the film.

This documentary has been compared with the docudrama released last December, The Big Short, which I reviewed here in a previous column. Boom Bust Boom is a much different film than The Big Short. Both are centered on the financial crisis of 2007-2008, but The Big Short is more of a narrative focusing on several real-life investors who discovered the precarious nature of the housing boom and invested short to profit from its imminent demise. Boom Bust Boom is more of a “talking heads” critique of the egregious failures of neoclassical economics with the addition of some puppetry and Monty Pythonesque humor.

I am quite sympathetic with two principal aspects of the documentary: (1) its criticism of the bankruptcy of mainstream neoclassical economics and (2) its laudatory comments about Hyman Minsky as perhaps the greatest economist of the last half of the 20th century for his financial instability hypothesis. However, overall the film emphasizes psychological causes of bubbles rather than rational, strategic ones. In other words, contrary to the thrust of this blog series, it tends to emphasize broadly-based human foibles as the cause of crises rather than the specific competition between concentrated bear and bull interests that I consistently highlight. In that respect, The Big Short is more illuminating.

Boom Bust Boom highlights behavioral economics, which is largely an application of experimental psychology. Indeed, one of its foremost proponents, Daniel Kahneman—briefly featured in the film—is the only psychologist to have won the Nobel Prize in economics. Behavioral economics shows that the “economically rational” behavior assumed in neoclassical economic models is not consistent with real human behavior. These findings are certainly a compelling reason to reject neoclassical consumer and investor assumptions, but theories of collective euphoria and panic tell us less about boom and bust cycles than Minsky’s own perspective, which focuses more on the expansion and contraction of private credit.

Economic booms typically do induce some degree of excessive euphoria, but such psychological reactions are not the primary cause of booms. Bullish expansion of credit, emphasized by Minsky but less central to the movie, is the primary cause.

Likewise, the “bust” occurs not because of irrational panic, but because of rational strategic moves by bears to tighten credit in their own interest. Although the secondary psychological reactions are real and important features of the boom and bust cycle, they are mass reactions, not the precipitating cause. The causes of both sides of the cycle are the strategic actions of bullish creditors to finance a boom and bearish shorts to staunch it. These are specific strategic actions, not merely broad human psychological tendencies. Their timing and alternation can be explained primarily as rational and self-interested behavior on the part of investors and purveyors of credit.

Using behavioral psychology to explain the boom and bust cycle is for me a little like using psychology to explain wars as a product of some innate human capacity for violence and aggression rather than the specific, strategic interactions of rival nations. Yes, humans do have some innate aggressive tendencies, but these do not explain specific wars, and certainly cannot explain the alternation between periods of relative peacefulness and more frequent wars. A relative constant like human nature changes only slowly, whereas strategic interactions explain specific dynamics much more precisely. Mass psychology is an inertial element, not the strategic core of social dynamics.

As I have often emphasized in this blog, I call myself a political economist rather than just an economist to emphasize the centrality of private power and strategy for understanding real economic dynamics. Far too many economists, even critics like many of those highlighted in the film, do not appreciate the strategic method I detail in Chapter 4 of my book, International Political Economy: The Business of War and Peace. Critics who want to model the economy as something mechanical, ignoring how the credit system creates polarized, opposing strategic interaction, are still too close to the methods of neoclassical economics to expose adequately its deepest weaknesses and vulnerabilities. As much as I appreciate Minsky’s work, his points would have been clearer if he had thought and written more about the strategic interaction of bears and bulls, the way, for example, Keynes does somewhat better in A Treatise on Money, highlighted in Chapter 5 of my book.

Both my strategic explanation of the business cycle and psychological ones are more pessimistic than textbook Keynesianism about the ability of governments, guided by macroeconomists, to deftly manage the business cycle and thereby maintain stable economic growth.

The behavioralists emphasize innate human irrationality as the main obstacle to better economic management, though it can perhaps be mitigated by institutionalized regulations that impose greater rationality than might be possible if individuals are freer to act on their unregulated impulses. Behavioralism thus promotes a sort of regulatory paternalism as the solution to wild human nature.

My perspective focuses attention instead on the specific activities, strategies, and investment designs of private investors taking rival positions that cannot all win. Bull-bear struggles guarantee that any direction the economy moves produces both winners and losers, thus there can never be any ideal state of the economy that contents every private power. This is the fundamental reason for polarization, and why capitalism is necessarily a two-party system, as James Madison explained in the opening paragraphs of Federalist 10 and I elaborate in my Chapter 2.

Most economists, even critics, are naïve about the prospects for sustained rational economic management less because of inherent human irrationality than because rival forces always contend. Private political struggle guarantees that no one state of the economy is ever permanent. Restlessly contending forces are always pushing in opposite directions. This is the real reason capitalist economies are perennially unstable. If you do not yet understand why, I invite you to read my book or review this blog series from the beginning.



James H. Nolt is a senior fellow at World Policy Institute and an adjunct associate professor at New York University.

[Photo courtesy of Wikipedia Commons]

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