BUSINESS CLASS: Imagination inflation

Our travels this week take us to an imaginary world where women run Wall Street and economists run the world, and where the commentariat debates endlessly over inflation... wait, that bit's real.

What if women ran Wall Street? Well, for starters, there'd be no bubbles. At least that's according "a new breed of researchers from the field of behavioural finance" who, says New York Magazine's Sheelah Kolhatkar, theorise that Wall Street is really just like your average angst-ridden adolescent – largely at the mercy of hormones.

"It’s the chemicals pulsing through traders’ veins that propel them to place insane bets and enable bank executives to make risky decisions... And because the vast majority of these traders and finance executives are men, the most important chemical in question is testosterone.

"The major plot points of the crisis largely turned on emotion," Kolhatkar continues. "Dick Fuld was too egotistical to sell Lehman Brothers when he had the chance...; Bear Stearns hedge-fund managers lost huge sums of money on subprime mortgages despite the fact that they suspected the worst ...; Merrill Lynch was ...so desperate to be like Goldman Sachs that it barrelled into every dumb investment imaginable... Almost every single bank chief doubled down on mortgage junk at exactly the wrong moment. Emotions led otherwise intelligent men – because, let’s face it, all of them were men – to make terrible decisions."

Or as John Coates – Deutsche Bank trader turned senior research fellow in neuroscience and finance at Cambridge University – puts it: "Every trader knows, when you’re on a winning streak you act like a dickhead, and then you end up giving back all the money you made on the way up." Who needs those academics!

The solution, obviously, is to have more women running the show. Coates – who Kolhatkar says is"positioning himself as a sort of endocrine whisperer of the financial system" – argues that if women made up half of the financial world, "I don’t think you’d see the volatile swings that we’re seeing." And we're betting you'd see a lot less high fives too.

But if you really want a picture of what Wall Street might be like if women ran it, have a read of this New York Times profile of Elizabeth Warren by Jodie Kantor. In it, the 60-year-old head of the TARP Congressional oversight panel and chief cheerleader for a new US consumer financial protection agency is variously described as: the "scourge of Wall Street bankers"; a janitor’s daughter turned speech therapist turned bankruptcy expert at Harvard Law School; a "former Sunday School teacher who cites John Wesley – the co-founder of Methodism and a public health crusader – as an inspiration", "a grandmother who can make grown men cry" (that's according to her husband, by the way, in reference to her famously fierce interrogation skills); "Socratic with a machine gun” (in reference to her teaching style); and "the most prominent consumer advocate in years". Be afraid, Wall Street.

What if...? Part II

And what would happen if Michael Lewis ran Wall Street? If Michael Lewis was God [What? He isn't?], says Jennifer Schonberger in The Motley Fool, "everything that could be traded on Wall Street would be traded through clearing houses or on exchanges."

Or in Lewis' own words, "there would be no such thing as me at Goldman Sachs being able to call you at Morgan Stanley and make a $5 billion bet on subprime mortgage bonds that basically isn’t on the books that investors can’t evaluate – or that, if Morgan Stanley goes down, no one knows whether it’s there or not... It creates all this uncertainty for the market. So all trading would be as out in the open as it could be.'"

What's more, God, er, Lewis "would 'insist' that the proprietary-like trading be done in a partnership structure, rather than in a public corporation," says Schonberger. "No partnership would ever be sitting on $50 billion of AAA-rated CDOs backed by subprime mortgages," says Lewis. "The attitude toward risk-taking in a partnership is just different. It’s not that partnerships can’t do stupid things, but it’s much less likely."

What if...? Part III

And finally, let us consider what the world would be like if economists were at the helm... A scary thought, to be sure. Still, it's worth having a listen to the Freakonomics podcast in which NYT blogger Stephen J Dubner discusses how the economist’s worldview differs from the politician’s, along with Steve Levitt, economics professor Russ Roberts, Mart Laar (the former two-term PM of Estonia widely credited with transforming the former Soviet republic into a "Baltic Tiger"), Milton Friedman's grandson Patri Friedman and, last but not least, a high-end call girl known to the Freakonomists as "Allie".

If you can't get to the podcast, check out this excerpt, in which Dubner and Roberts play a "fantasy game", in which the latter is "a creative and very bright economist ...put in charge of the whole country."

Says Roberts: "I’m getting goose bumps, it’s so exciting. [We're right there with you, Russ.] ...I would get rid of the Department of Commerce... I’d get rid of the Department of Education... I’d get rid of all tariffs. ...I would get rid of the minimum wage law... I’d change the Federal Reserve. ...I would certainly at a minimum require it to only care about price stability. ...I would probably replace the Fed with a Friedmanite fixed growth and money supply or just abolish it entirely and let private money emerge. I’m getting out of control here." As you can see, it's a must hear.

Don't believe the hype

Another week, another economic sparring match starring New York Times heavyweight Paul Krugman. The topic this week is inflation – or to be more specific, the fear that the US government will go mad and inflate away the nation's debt – aka hyperinflation.

The debate kicked off over a week ago with an "odd piece" (them's Krugman's fightin' words) by The Atlantic's Michael Kinsley. In short, Kinsley's position is, "Am I crazy, or is the commentariat ignoring our biggest economic threat?"

Krugman's swift response: Crazy? No. Out-and-out wrong? Damn tootin'! He then proceeds to school Kinsley on why inflation isn't an imminent threat, as well as patiently explaining that hyperinflation is, like, toootally different to inflation.

"Hyperinflation is actually a quite well understood phenomenon, and its causes aren’t especially controversial among economists," says Krugman. "It’s basically about revenue: when governments can’t either raise taxes or borrow to pay for their spending, they sometimes turn to the printing press, trying to extract large amounts of seignorage – revenue from money creation. This leads to inflation, which leads people to hold down their cash holdings, which means that the printing presses have to run faster to buy the same amount of resources, and so on."

And Michael Avent of The Economist's Free Exchange blog expands on that. "There is a massive difference between printing money to pay off debts and printing money to erode the real value of debt," he says. "And there is a big difference between governments that are reluctant to opt for painful budget fixes and governments that absolutely cannot do it."

The truth about hyperinflation, says Avent, "is that it isn't so much an economic phenomenon as a political one; it corresponds to the complete breakdown of a country's political institutions." Moreover, he adds, "the pain of hyperinflation is every bit as bad as and worse than the pain of tax increases, or spending cuts, or default. No (American) politician would risk it, and even if the politicians were willing to, America's independent Fed wouldn't let them."

And the coup de grace; "To get from America's current situation to one in which hyperinflation is a realistic possibility, one must pass through an intervening step in which America's political institutions utterly collapse. And I submit that if Mr Kinsley has reason to believe that such a collapse is imminent, he should be writing columns warning about that rather than the economic messes which might follow."

The NYT's 'Economix' blogger Catherine Rampell also weighs in, arguing that inflating away America’s debt is an unlikely option "not because it’s too painful for politicians to implement, but because it wouldn’t work. Too much of the country’s debt is indexed to inflation, either directly or indirectly (as with future Medicare liabilities). Even if government printing presses went gangbusters, Berkeley’s Alan Auerbach calculates, 90 per cent of the country’s debt problem would survive."

And just in case that's not enough to reassure you that America's gigantic pile of debt is going nowhere, here's Felix Salmon on why he, too, is unfazed about hyperinflation. And if your thirst for inflation nous is still not sated, Krugman has set some required reading. Hop to it.