It’s particularly relevant to this week, as well. We’ll get to why that is in a second.
Simply put, it’s the idea that the world economy is a ‘machine’ that can be messed with, tweaked and somehow mastered by the authorities. You see a lot of this these days. You read people claiming central bankers have ‘levers’ they can pull on to influence the economy, as if it’s as simple as driving a car.
The problem is, the second you believe the economy is something the authorities can control like some benign man-made machine, you’re in trouble.
There are some things central banks and governments can do to change things in the economy. They can drop interest rates to try and grow the money supply. They can raise them to try and get it under control. But it’s not as simple as pulling a lever or pressing on the accelerator of a car and watching the speedometer rise.
I’ve always thought a more apt metaphor is to compare the economy to that of a natural ecosystem. An infinitely complex web of plants and animals, all acting according to their own interests and desires, that makes up a much wider system.
Now, humans can influence nature directly.
But we cannot control it. We can barely understand what our actions will do.
Let’s take an example. Yellowstone National Park in the USA.
Back in 1995, ecologists in America had become worried about the worrying drop in numbers of grey wolves all over the country. They were being hunted out of existence. So, 20 years ago, they decided to try and fix the situation and quietly started reintroducing wolves to Yellowstone.
The effects of that one decision were mind-bogglingly complex.
There hadn’t been any wolves in Yellowstone for 70 years. That meant the numbers of deer in the park had skyrocketed, despite human efforts to control the population. Not only that, the deer had massively reduced much of the vegetation of the park through overgrazing.
When the wolves arrived, that changed.
And not just because they hunted and killed some of the deer. The wolves also had a – I use this term loosely – a psychological effect on the remaining deer population. The deer started avoiding certain areas of the park, due to the threat of being hunted. They avoided valleys and gorges and other places they could be trapped easily.
Immediately, the landscape in those places changed. Places that had been barren a handful of years before became great forests. The height of some trees quintupled in less than a decade.
As soon as that happened, huge numbers of birds flocked to the new forests. The population of beavers exploded, changing the ecology of the rivers and marshes. The entire ecosystem altered. The numbers of hawks, rabbits, badgers, rats and bears all shot up.
But perhaps the most interesting effect of the wolves was their impact on the rivers of Yellowstone.
The increased vegetation and plant life changed the nature of the soil on riverbanks, decreased erosion and stopped the rivers meandering, making them flow faster and straighter and reshaping the fundamental landscape of the park.
My point is, in a complex ecosystem even seemingly simple actions can have profound, long lasting and unexpected effects.
Who would have thought reintroducing wolves to a national park would change the direction of the rivers? Who could have understood that? And who could possibly hope to control the process?
OK, weird ecological tangent over. Back to finance and economics. The same idea applies. The economy is just as intricate and complex as the ecosystem of a natural park. And trying to control what’s happening in it will have just as many unexpected and uncontrollable side effects.
This isn’t new, by the way. Although it might feel like it when you read the paper or watch the news. The French economist Frederic Bastiat explained this idea almost 200 years ago in his essay, What is seen and not seen’
“In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.
“There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.”
What’s unseen are all the profound and long lasting effects that would have on the landscape: the other animals, the trees, the rivers changing course.
It’s easy to spot the first effect. That’s why so much financial analysis focuses on it. So, if Janet Yellen keeps rates at 0.5% tomorrow, the whole world will see it. It’ll be an obvious, first-order influence on the financial system.
It’s the unseen effects that we need to worry about. How do zero interest rates warp the psychology of investors? Are we bringing up a whole generation of people to favour spending and borrowing ahead of saving? Can traders and investors and bankers and hedge fund managers even cope with a world where the Fed doesn’t step in to stop markets falling?
It’s harder to know this sort of stuff.
• This article is taken from the free daily email Capital & Conflict.