The Nature of Panic

Once again today, the world stock markets are in free-fall as the worldwide herd of investors stampede to the exits. Politicians have that “deer in the headlights” look, and central bankers keep pulling one lever after another hoping that something will work.

The problem, as I see it, is that those in charge may understand economics but they don’t understand human psychology. They are trying careful, rational actions in the hopes of controlling irrational behavior – but it doesn’t work that way.

Human groups en masse behave much like schools of small fish or large flocks of birds, moving as a unit. An economist named Lake LaBaron at Brandeis University has built a simulation of the stock market that can reproduce fairly accurately the sort of irrational herd behavior that often grips the markets, just as it is doing in the real markets today.

American hunters knew that to control a stampeding herd of buffalo it took dramatic actions – gunshots in the air, strategically-placed grass fires, or lines of hunters waving big buffalo skins – to get them to change course.

What governments and central bankers have to understand is that the small, conservative stepwise changes they have been trying day by day can’t control an irrational stampede. It takes big, impressive, dramatic steps to divert a stampede – a “slap in the face” of some sort. In 1933 Franklin Roosevelt declared a bank holiday to stop the run on the banks that he faced, and it worked. Today’s leaders need to try something similarly dramatic to halt the stampede and give spooked investors time to regain their composure and come to their senses.