“A lot of what keeps some economies immune is the fact that people think they’re immune. Believing makes it so. And that’s very good.”

– Paul Krugman, MIT Economist

A dangerous notion is currently gaining credence among global policy-makers: perception “creates” economic reality. This idea suggests that economic reality is mutable, floating only in the consciousness of the populace, and subject to its whims. In other words, weak economies with poor economic policies can miraculously flourish due to positive sentiment. (And strong economies with excellent policies can be wrecked by a lack of “faith”.) The logical conclusion is that, if you can fool citizens and investors into feeling confident, then economic reality will conform to their delusion.

Bill Clinton recently called for lines of precautionary credit to help “countries with sound economies avoid financial instability”. If a country has a “sound economy” one wonders how it could run into “financial instability”. The modern explanation is that “irrational sentiment” combined with “hot money flows” somehow sends good economies to their doom. Clinton never seems to consider that investor perceptions might be correct and that IMF and government policy is wrong.

To counter some of the recent rewriting of history, here is the simple reality of the facts surrounding recent emerging market crises: Certain countries promised to maintain long-term currency stability, promises that rightly fostered investor optimism regarding the economic prospects of these countries. Yet some of these countries followed incompatible policies; they increased government spending, ran higher deficits, and financed it with foreign loans. Economic growth then began to stagnate. Eager to ease this burden, the IMF recommended a program of currency devaluation followed by increased taxes (to boost “competitiveness”). When these deplorable policies were enacted (or became probable) markets rightly perceived disaster and fled from those countries’ assets.

To the new economic spin doctors, currency devaluation and higher taxes are characteristic of “sound economic policy”. They name-call investors who disagree with their policies “irrational speculators”, “hot money investors”, or even “financial pirates”. As such, capital flight constitutes an unjustified and inexplicable loss of investor trust, which must be immediately addressed through additional multinational bureaucracy.

The Wall Street Journal reported this week that the IMF is planning to put Clinton’s advice into practice. They were prepared to offer as much as a nine billion-dollar “precautionary” credit line to Mexico, more or less a pre-approved bailout plan. While the loan is intended to allay investor concerns and bolster confidence that Mexico’s foreign reserves are sufficient to protect the peso from currency speculation, I would argue that the credit-line makes Mexico more, not less, risky.

First, the credit could lead Mexico’s politicians to believe that they need not worry about solid economic fundamentals (since they’ve got reserve cash). Secondly, economists may feel free to pursue a more “flexible” (i.e. weaker) currency policy without risking the sudden inability to refinance government debt. And thirdly, these backup credit lines ensure that the IMF and its muddle-headed economists will play a significant role in Mexico’s economic policy decisions.

Will $9 Billion really buy additional investor confidence in Mexico? If the government chooses to follow unsound economic policies, it won’t buy any more confidence than $41 Billion bought Brazil just two months before their economy unraveled. Despite new economic theories to the contrary, reality determines perception, not vice-versa.


If recent history is any indication, there are many “experts” within the IMF that firmly believe that devaluation and tax hikes constitute sound economic policies for developing nations. Yet when these sanctioned policies are implemented, all hell breaks loose as beleaguered investors, feeling justifiably betrayed, flee for the exits. From lofty seats perched high within enormous bureaucratic edifices, IMF and academic economists have great difficulty accepting the fact that their policy recommendations fuel economic disasters. Instead, they prefer to blame “mistaken investor perception” for resulting damage.

The “perception creates reality” point-of-view is now en vogue because it absolves misguided theoreticians of responsibility which might otherwise rest squarely on their shoulders. This latest “economic spin” allows them to cling to trendy, yet inherently flawed economic theories currently being batted around at D.C. country clubs and in the hallowed halls of MIT, Harvard, Stanford, Berkeley and Yale. They can believe their economic rhetoric is sound and that unwarranted investor pessimism “causes” imperfect markets.

It is disturbing to witness government officials and trusted economic advisors increasingly wielding the “perception is reality” concept. In the same way that President Clinton deftly “manages” public opinion, policy-makers now use collaborators and aides to propagate untruths about basic economic reality. The objective seems to be to manipulate investor perception to justify policies which are fundamentally insupportable. Take for example the recent case of Robert Rubin and Brazil.


Secretary of Treasury, Robert Rubin, is a great spin master. He has loads of experience in controlling public perception. He’s spun elaborate untruths in support of President Clinton and is clearly willing to do the same for his global economic agenda.

Case in point: Not 24 hours before the recent economic unraveling of Brazil, Rubin was vocally insisting that President Cardoso was “100 percent committed to doing what needs to be done”. For whatever reason, it was clearly very high on his agenda to boost investor confidence in the Brazilian market. And yet, the very next day Brazil began its disastrous devaluation. The IMF foolishly supported the move and Rubin, who clearly should have known better, shamelessly defended it: “Brazil acted this morning to enhance the flexibility of its exchange rate system.” Give me a break!

Further acting on the premise that “belief” and “faith” are more important than economic fact, Robert Rubin was recently quoted proselytized to Wall Street on Brazil’s behalf. Trying to round up even more credit for Brazil’ s struggling banks, Rubin stated that “We believe that firm and sustained implementation of [the IMF program] can preserve financial stability, safeguard the significant results achieved under the Real Plan, and lay a solid basis for restored confidence and renewed growth”. Rubin then flagrantly urged Wall Street to fund Brazilian debtors: “Substantial participation by Brazil’s private sector creditors is important to Brazil’s economic program… Brazil’s success in preserving stability…is of critical importance to the United States…”

Does Rubin think that global banks are daft? Are they really too unenlightened to make profitable loans without his urging? If loaning money to Brazilian banks was good business, American financiers would be beating a path to their door. But if loaning money to Brazilian banks is a fool’s game, then Robert Rubin is singing a Siren’s Song luring American financiers to financial doom.

Will the financial community buy into the rosy Brazilian picture that the IMF and other politicians are painting for them? Probably not, unless they are being assured with backroom promises that their losses will be accompanied by further governmental bailouts. So far, markets have been pretty capable in distinguishing reality from propaganda, to the dismay of countless political meddlers.

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Andrew West

Andrew West is a Contributing Economics Editor for Capitalism Magazine. In 1997 he received the Chartered Financial Analyst designation from the Association for Investment Management and Research.

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