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A reliable guide

7 November 2014 By Edward Chancellor

What is the glue which holds an economy together? Disciples of Adam Smith would argue that self-interest serves as the organising principle. The problem with this way of thinking is that it overlooks the fact that man is not an island unto himself. He is a social animal, who must have constant dealings with other people. Besides, according to John Maynard Keynes, it is impossible to pursue our self-interest rationally, because we don’t have enough information to make probabilistic judgments about the future. Instead, we must rely on irrational animal spirits as a spur to action.

Trust, as Geoffrey Hosking points out in his engaging book, “Trust: A History” (OUP), provides a substitute for prescience. The unchecked pursuit of self-interest can undermine trust. The financial crisis which followed the 2008 bankruptcy of Lehman Brothers reminds us that when trust evaporates, the financial system ceases to function and the economic activity shrinks.

Hosking traces the genealogy of trust from its origins in family life, where it is imbibed in infancy, through organised religion – faith and trust being closely related concepts – to its secular role in modern economic life. Throughout this progression, our capacity to trust has become ever more extensive. “The advantage of being able to trust one another,” wrote John Stuart Mill, “penetrates into every crevice and cranny of human life; the economic is perhaps the smallest part of it, yet even this is incalculable.” Or in the blunt expression of one sociologist cited by Hosking, without trust we could not get out of bed in the morning.

Market economies depend on trust as well as self-interest. “Trust,” writes Hosking, “is an indispensable component of courage.” Without trust, there can be no entrepreneurs and no risk-takers. Trust lowers transaction costs, because less time is spent investigating those we might have dealings with. Trust also solves the supposed problem of cooperation raised by game theory, which starts with the premise of unmitigated self-interest. When a high level of trust prevails in a society, there is more cooperation and everyone ends up better off. Economists have found that trust is correlated with economic output, savings and investment, the efficiency of government and the willingness to pay taxes.

Money, writes Hosking, makes trust economically effective. It expands the realm of trust, whilst simultaneously depersonalising it. Money only has value because we trust it, and this trust is backstopped by our trust in the government of issue. Our faith in money represents a belief that society will collectively honour its obligations. When that belief is threatened, money loses its value. Hyperinflation beckons.

It is often claimed that corporations are soulless and amoral entities. In fact, they depend upon both internal and external trust for their very survival. As the Enron disaster showed, when trust evaporates within a corporation the business implodes. Brands – the commercial embodiment of trust – thrive in high-trust societies such as the United States and Japan. In low-trust societies, businesses are generally organised along family lines and large companies tend not to take root. This explains why China, a low-trust society plagued by corporate scandals, has had such problems establishing global brands. Low-trust societies are also characterised by higher levels of government corruption and organised crime. They fall into a “social trap,” a vicious cycle of economic stagnation from which it is difficult to emerge.

The ebb and flow of the business cycle can be seen as movements in the tide of trust. During the boom period, we become too trusting. Our business dealings become careless. The untrustworthy emerge to take advantage of these circumstances. Fraudulent activity, or what J K Galbraith called the “bezzle,” increases. A speculative bubble is the consequence of excessive trusting.

Yet financial trust is inherently fragile. “The peculiar essence of our banking system,” asserted the 19th century British journalist Walter Bagehot in Lombard Street, “is an unprecedented trust between man and man; and when that trust is weakened by hidden causes, a small accident may greatly hurt it, and a great accident for a while may almost destroy it.” The financial crisis is a period of acute, if momentary, distrust. “Everybody is suspicious of everybody,” says Bagehot, “as soon as that calamity is forgotten, everybody again confides in everybody.”

Hosking has chosen an excellent time to re-examine the role of trust in our life. He provides a readable synopsis of the often turgid writings of sociologists and anthropologists on this subject. An historian of Russia by training, Hosking compellingly describes the complete breakdown of trust in the Soviet Union, to which he ascribes many of Russia’s subsequent economic problems. Hosking has deep insights into the relationship between trust and money.

Unfortunately, his knowledge of economic history is not always up to the task (at one point he alludes to the failure of the Bank of New York in December 1930 when it was the collapse of the Bank of United States on that date which triggered America’s Great Depression).

Hosking claims there is a crisis of trust in the Western world. In the years before Lehman’s bust, the distribution of generous incentives (read bonuses for bankers and stock options for corporate executives) encouraged reckless behaviour in the business world. Furthermore, quantitative credit tools turned out to be faulty instruments for discerning where trust should be reposed. In the end, bank credit must always depend on the exercise of what Bagehot called “real sound sense.” This was sorely lacking in the years leading up to the global financial crisis.

Hosking points out when trust in banks started to fail, governments were obliged to support them with public credit. In the subsequent years, government debt levels around the world have swollen to very high levels and major central banks have grossly expanded their balance sheets, printing money out of thin air. No one knows how this extraordinary monetary experiment will end. For the moment, trust in government credit and money remains strong. Politicians and central bankers must tread carefully. If this trust is ever impaired, then we will witness a real crisis.


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