Economics: A Study in Group Psychology

by Peter Hiddema

I assume this title is self-explanatory for most of you reading this article.  Moreover, my guess is it wouldn’t be too hard to agree with this statement. 

I remember sitting through sleep-inducing “Economics 101” lectures back in the first year of my undergraduate degree, listening to the professor describing consumers as “rational actors” and thinking, “yeah, right!” 

One of the foundational premises of economics is the notion that we as individuals make rational choices about various possible ways of allocating our limited resources among alternative uses.  At the time I think I took it on faith given the intellectual authority of the esteemed professor with his credibility-enhancing British accent, or was too busy sleeping to argue, or both.  I remember wondering about this notion, thinking it was too neat and tidy, but, I left it at that. 

Since then, my 25 years of life experience and 20 years of work experience, traveling through over 60 countries on every continent except Antarctica, living in 5 of them on 3 continents, and working in this field that studies human behaviour, I have come to regard many of the actions we humans take as being anything BUT rational.   

All you have to do to is look at how you (and your fellow “competitors”) behave during a sale of a hot item to analyze that scenario.  Consider the actions of multiple bidders on a real estate property in a hot market.  If you’ve been one of them, can you really say all of your actions were rationally driven?  Really?  I’ve been one of those crazed people, and trust me, I was NOT being a “rational actor”.  My emotions got hooked into the equation – even my identity in some way, I would say – and that drove some of my key decisions.  

Now, use this lens to look at a number of economic situations of days gone by, such as:

  • The “dot com” bubble and burst of the year 2000(?)
  • The real estate bubble of the early 2000’s and subsequent burst in 2008
  • The stock market bubble and burst of the same period
  • The oil price spike and plummet of 2008
  • The dramatic drop in worldwide commodity prices in 2008

Yes, there were “fundamentals” underlying all of these events.  Said differently, there were things that had gone past their sustainable levels.  AND, now they are way below their sustainable levels.  

Why?  Because of group psychology, I believe. 

If we look at only the last economic cycle, we could clearly see that “the fundamentals” were out of whack for quite a while.  Housing affordability was at record lows yet kept making new record lows, prices in the stock market seemed to far outstrip the sustainable earning power of the underlying companies, etc.  

So why did things keep going up? 

Because enough people believed they would keep going up, so enough people kept buying, proving the others (and themselves) right.

This all continued until we reached an arbitrary point at which enough people started to say, “this is too far.  We can’t keep doing this, and started to sell.”  

And now, we’re in a period where so many of us are scared, we’ve sold too much.  Things are too low now.  We’re below what “the fundamentals” would say we “should” be doing as “rational actors”.

Why?  Group Psychology.

Too many of us are scared, and too few are ready (yet) to make the first bold moves. 

When will it stop?  When will it start to turn around?  When enough of us – at some arbitrary point – say, “OK, things are bad enough now, and they’ve been bad enough for long enough.  I guess it’s safe to buy now because there are good deals out there.” In fact, the turnaround may have already begun, but we just aren’t hearing about it. 

Again, group psychology.

Now if you call that “rational actors” making choices to allocate their limited resources among alternative uses, I’d love to talk to you about how and/or why, because I must be missing something massive.  

To the circus we call “life”.

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