When confidence is lost

A scary day.  Here in London people are appalled by the looting and burning, and angry and panicked.  Something analogous is going on in the world’s financial markets.  At times like this we realise how much of a modern society is built on trust and confidence in strangers.

On the streets we hope that our well-ordered and safe lives are built on more solid foundations: law and the agencies that enforce it.  But in fact it depends on almost everybody imposing voluntary boundaries on their behaviour.  Even a tiny minority can create havoc.  If it truly is a tiny minority then we can contain it, but at the cost of deadening society around us and reducing the level that different communities mix.  It’s impossible to know where we will end up, but our town centres may never recover and the divisions in our society may simply grow.

The financial markets are likewise built on trust.  We also like to think that it has more solid foundations, on decisions taken based on solid information, with effective regulation and security.  Alas no.  Decisions are taken in an instant, and often by computer algorithms with a limited digital input.  A lot has to be taken for granted, so when confidence diminishes panic is likely to follow.  One of the more irritating aspects of these markets is the way people jump to quick explanations as to why a market has moved in a particular direction.  This week there was a lot of talk about the downgrading of US debt.  But the causes are unknowable, the sum of many decisions based on partial information and individual circumstances.

The downgrading of US debt simply cannot be a rational explanation.  It was based on no new knowledge; it directly affects investors only at the margins.  US debt actually rose in price, while share markets tumbled.  Share prices had in fact mostly lost touch with reality anyway, so a sharp fall in value should hardly have been a surprise.  The ability of professional investors to accept clear nonsense as a basis for valuing shares is one of the remarkable features of modern finance.

The panic will subside.  Life must go on.  But the difficult times will continue, both in the economy and civic cohesion.