Wednesday, September 06, 2006

Perception and Finance 

I read over the weekend a depressing but well-argued book on generational accounting called The Coming Generational Storm. It discusses massive debts coming due in Social Security and Medicare as Baby Boomers retire and lays out page after page of evidence for the authors' views. One passage in the book is testimony to the power of perception and its impact on human affairs. The authors' are writing about the collapse of countries when debt becomes too large. They use the example of Argentina.

If everyone believes that everyone else believes that Argentina is getting into trouble or could be getting into trouble, everyone raises the interest rates at which they lend to the country. The higher interest rates then put the country into a recession, forcing it to default on its loans and to use the printing press (inflation) to pay its bills. Hence, the original beliefs about default and inflation become self-fulfilling prophecies.

Everyone knows finance systems are built on credibility, but this is a succinct way of stating the case and a powerful example of perception becoming reality.


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