Political and financial bubbles are driven by social norms.
Published on February 22, 2011
What does the price of gold have to do with Libya?
This is not a trick question, nor is it a tale of international banking and intrigue. It is a story of bubbles.
As of this morning, the price of an ounce of gold is $1403. People concerned about the state of the world economy have stopped buying stocks and bonds and started putting their money in gold. This demand has drive prices up.
In Libya, people have taken to the streets. Despite military crackdowns that have killed an untold number of these protesters. The people of Libya have been inspired by events across North Africa and the Middle East, and have decided that now is the time to force a change in their government.
There are lots of factors that lead both to stability and change in politics and finance. But, the psychology of these cases is fascinating as well.
First, why are there so many people who are willing to enter into a market for gold? Why did the people in countries like Tunisia and Egypt live peacefully for so long under governments that they felt were corrupt?
Both of these situations reflect a general tendency for people to reach a consensus that governs our social world. In a classic book from 1936, Muzafer Sherif described a brilliant study on the development of social norms.
In this study, a group of people sit in room that is completely dark. A pinpoint of light is shined on a wall of the room. Strangely, under these conditions, even though the light does not move, it will appear to move around. This illusion is called the autokinetic effect.
Sherif had groups of people watch this pinpoint of light and then tell the rest of the group how much the light seemed to move. Then, they would watch the illusion again and make another estimate of the amount of movement. Over time, the group would come to agree on how much movement the light was making. Different groups would settle on different amounts of movement.
Ultimately, though, the group creates a consensus about what they think is going on. Similarly, in the gold market there is consensus among investors that gold is valuable and that it is a safer investment than stocks, bonds, or real estate. This group consensus keeps prices high.
Similarly, the people in a country generally reach a consensus that they will go on with their daily lives, even when they think that there are elements of the government are unjust. Certainly, there is a vague threat that the military might crack down on protests, and occasionally people are arrested for going against the government, but the majority of people simply go about their daily lives.
If the prices of a commodity like gold get high enough, though, the price people are paying outstrips any inherent value of the product. Gold has lots of uses, but the value it has right now is being driven by the fact that people think it is valuable. Similarly, when a regime gets repressive enough, it may be difficult to justify living under its rule.
At that point, people become susceptible to another force on action called goal contagion. Heng Aarts, Peter Gollwitzer, and Ran Hassin gave a number of clever demonstrations of this phenomenon in a 2004 paper in the Journal of Personality and Social Psychology. In each of these studies, they demonstrate that people who see the actions of people around them are likely to adopt the same goal. Watching a person help others can lead you to want to be helpful yourself. Goal contagion is another powerful mechanism for creating social norms.
In the case of political and financial bubbles, goal contagion can create the force to pop the bubble. In Tunisia, a man who set himself on fire in protest captured people's attention and led to widespread civil unrest over a period of a month. As the people in neighboring countries watched these protests unfold, they began to take on the same goal and the protests have rippled through the region.
And one day, a prominent investor is going to start selling off gold. At that point, other investors are going to be influenced to adopt the same goal. At the point where the sellers outnumber the buyers, gold prices will fall. The consensus will change, and people will scratch their heads wondering how gold prices could have risen so high.
These consensus effects are so powerful that when people are in the grip of this shared world view, it seems impossible to imagine that the world could be any other way. Five years ago, home prices were rising steadily, and mortgage lenders and Wall Street brokers could not imagine a world in which prices fell. Prices for mortgage-backed securities remained high long after it should have been clear that many of the loans underneath them were never going to be repaid.
A year ago, I am sure that nobody in Tunisia or Egypt would have thought it even remotely possible that they would throw off their governments. And those people buying gold right now may have trouble believing that gold prices will fall. But history and psychology suggest that gold prices will fall and soon enough investors will flock to the next bubble.
Follow me on Twitter.
Post a Comment