10 October 2008

Have you noticed how all the world's most learned economists so accurately predicted the current financial melt-down? How they warned that Iceland was about to teeter on the edge of insolvency? That after the US Congress passed the bank bail-out plan last Friday, share prices in New York and London would plunge yet further on Monday?

You haven't? No, nor have I. That's because the study of economics is no use at all in the current climate. What you need is idionomics. Don't worry, I'm an expert.

The starting point in the study of idionomics is a simple principle: No one understands anything. From this it follows that any pundit pretending to understand isn't worth listening to. (I naturally exempt all BBC colleagues, who seem uniquely able to explain what is happening, even if, like everyone else, they find it more difficult to predict what will happen an hour from now.)

Which brings us to the second fundamental principle of idionomics: Never predict the future; always confine yourself to explaining the past. (Many economists observe this principle even without acknowledging their debt to idionomics.)

The third principle combines two, apparently contradictory maxims: however bad it is today, it may well be worse tomorrow -- but never assume that because it's bad today, it will be worse tomorrow. This is sometimes called the "random unpredictability factor", and only very rich people fully understand it.

By the way, if you ever make it through to advanced idionomics, you will find yourself grappling with the difficult concept of "rich does not equal clever". This can be summarised (and simplified) by stating that very rich people should not be regarded as very clever. They are simply very rich.

I risked the scorn of my peers three weeks ago by writing in this newsletter: "I hope I'm not being a total simpleton if I suggest that some of the coverage of recent events risks losing a sense of proportion." And well, well, if I didn't read in the Wall Street Journal a couple of days ago:

"The magnitude of this financial disturbance should be placed in perspective. Although it is the most severe financial crisis since the Great Depression of the 1930s, it is a far smaller crisis, especially in terms of the effects on output and employment. The United States had about 25% unemployment during most of the decade from 1931 until 1941, and sharp falls in GDP. Other countries experienced economic difficulties of a similar magnitude. So far, American GDP has not yet fallen, and unemployment has reached only a little over 6%. Both figures are likely to get quite a bit worse, but they will nowhere approach those of the 1930s."

The author was Gary Becker, who won the 1992 Nobel prize for economics. And he's clearly studied idionomics as well, because he also writes: "The main problem with the modern financial system based on widespread use of derivatives and securitisation is that while financial specialists understand how individual assets function, even they have limited understanding of the aggregate risks created by the system. That is, insufficient appreciation of how the whole incredibly complex financial system operates when exposed to various types of stress."

Which is an uncannily accurate paraphrase of the first principle of idionomics: No one understands anything.