The Basis of Trust and its Effects on Modern Economic Interaction

In chapter 6 of When The Money Runs Out, Stephen D. King argues that the lack of trust in the modern economy and our modern financial sector creates broken economic situations that cannot easily be repaired, causing economic stagnation especially occurring when people become distrustful in their transactional processes, and usually generated through the immoral origins of those wishing to maximize their profits. He states, “Indeed, in the absence of trust, human interaction becomes increasingly corroded”[1] implying that speculative confusion created by a lacking of accurate and trustworthy information will ultimately make people act irrationally and in hasty modes of self-preservation. He argues that asymmetries of information often cause price evaluations to be grossly off their true mark, as a product of economic “bad behavior”, and that this causes individuals to attempt to game each other. This behavior is the driving force that creates the hiked up prices on goods that should not be priced as high and lowering prices on goods that should be, as well as indulging in institutional malpractices which eventually leads to economic stalemates and recessions. “Virtually every commercial transaction has within itself an element of trust, certainly any transaction conducted over a period of time. It can be plausibly argued that much of the economic backwardness in the world can be explained by the lack of mutual confidence.”[2] King says that trust and similar values such as loyalty and truth-telling are goods, and with them our efficiency as an economy increases and growth is enabled, due to more effective resource allocation as a collective and safer economic processes for the whole. In chapter six of When the Money Runs Out, Loss of Trust, Loss of Growth, King talks about how without these goods and with the loss of trust in our economic institutions, whether they be financial, business, negotiatory, or of other economic activity, the unscrupulous methods and dishonest practices that enable unfair economic behavior disable our economy and doom it to deliver less for the many and more for the few. This has the potential to mangle our collective good-faith in our economic institutions in the process and cause future instability.

Trust From the Public is Only as Volatile as the Economy’s Health

Providing an introductory example of what he means, King uses the analogy of a used car salesman selling a “Lemon”, a car that’s in bad shape but is being sold as if it’s in perfect condition. Car salesmen will know this is the case, and the buyer will not. There is an imbalance in information that creates distrust and further confused and irrational behavior that’s engaged in in order to compensate. The buyer lacks trust in the seller’s claims of the car’s perfect condition and barters for a lower price. In order to counter, used car salesmen drive up the prices of their goods before the bartering even takes place, in order to maximize the profits by creating an upwards surplus of the true value of the goods being sold. This is just one example of the actions that take place in business, finance, and other areas of the economy that generates distrust in individuals, organizations and systems, and ultimately leads the economy to stagnation and market uncertainty.

King explains in this chapter that banks are often the main target of frustration and mistrust during these economic downturns. Stating that the general public has been “unusually supportive”[3] of government regulation in banking and financial institutions because of this lack of trust since 2010. He goes on to talk about how the banking systems have dealt with volatility of public approval throughout the years since 1980. Survey approval levels fell from 60 percent to 30 percent in the early 1990s, and rebounded during the 2000s back to 53 percent but subsequently fell back to 18 percent following the aftermath of the Great Recession. The cyclical nature of the changing positive and negative approval rates for bankers was calculated by a San Francisco Federal Reserve Bank, finding that “two-thirds of the recent decline in trust [in banks] is explained by the cyclical downturn.” And while intuitively, our mental notion might be that due to the cyclical nature of these economic ascensions and declines, it's only a matter of time before we see an economic upswing that reverts the cycle and reaffirms our position in having healthy perceptions and trust for our banking and financial institutions, King says this may be wishful thinking. He states, “should a lack of trust prevent recovery from materializing, the cyclical argument would no longer hold.”[4] Banks have often attempted to reaffirm trust within themselves after instances of malpractice and breaches of ethics, but often with very shallow and meaningless statements of apology and inauthentic assertions for future “compliance with the law and regulations”.[5] This only exacerbates the situation that leads to mistrust in the public eye as well as economic fragmentation and challenging obstacles from distrustful customers, but, King states, this also leads to mistrust and lack of faith from within the institutions themselves.

Lack of Trust from the Inside

King talks about the process in which banks stop trusting themselves. During the housing market crash of 2008, the interbank market, which is the banking market that allows institutions to deal with liquidity shortfalls and excesses, began to rise in interest rates. Investors started selling more shares due to the belief that those inside the interbank market might have “inside knowledge” of the state of the individual bank’s solvency levels, showcasing again the lack of trust that individuals have in institutions based on financial market factors in motion. They feared that the rise in rates ultimately meant that the banks were losing liquidity and were going to be going into a debt crisis, all the while investors also realized that the institutions were failing and stopped buying shares, cutting off the banks source of lending. It is this form of circular happenstance and slippery slope reasoning by groups of mistrustful individuals that ultimately creates a self-fulfilling process when it comes to institutional failures within the finance world. The speculation by investors that’s often based off different market factors and capital movements within the markets creates unrest and an irrational impulsivity, ultimately perpetuating scrambles of buying, selling, and destructive financial moves in order to try to gain a leg ups on other individuals and institutions feared to have information they do not.

The Subprime Mortgage Crisis

During the subprime mortgage crisis, we see dishonesty and financial lack of regard for others and economic stability on rampant display. The subprime loans being given out were being issued with very little attention to the capability of debtors to pay back the loans they were receiving. And due to the “Freudian illusion”[6], a belief in continued everlasting financial growth and an unquestioned capability to pay back their creditors, these debtors didn’t realize that the enormous amounts of debt they were taking on was ultimately allowing a bubble to form in the housing market. Borrowers were taking on extremely expensive debt, sometimes from lenders that were offering interest rates on short-term loans as high as 1 percent a day and borrowers were happily taking this on. While financial irresponsibility and wishful-thinking of achieving the “American Dream” of owning a home perpetuated the risky borrowing from lenders, capital markets also share the blame for creating “daisy chains” of debt, investors linked to savers through selling debt obligations to banks that assembled mortgage bundles that when broke apart caused the entire system to fail. Savers with no connection with homebuyers, often thousands of miles away, were inexplicably connected with debtors through capital innovation chains that financial institutions formed on the belief that the housing market would never fail and that people would never not pay their mortgage. When the crisis came however, the faults of both creditors and borrowers were on display as the housing market collapsed due to borrower defaults and economic growth began to slow worldwide. Debtors were unable to pay back the money they owed to creditors on both domestic and international levels causing economic stagnation and facilitating a lack of trust between the public and financial institutions.

Who Are the Winners?

Ultimately, in times of strife there may indeed be no winners. Financial institutions lose trust in one another. The public loses trust in its financial institutions and governments spend money bailing out failing institutions through its citizens' taxpayer dollars. Stagnation within the economy creates government regulation that disallows individual economic freedom and creates rifts in political ideology that hampers civic discourse, and political cohesion. Former Harvard Public Policy Professor Robert Putnam says “features of social organization, such as trust, norms, and networks, can improve the efficiency of society by facilitating coordinated actions.”[7] If people trust each other they are more likely to engage in trade, they are more likely to invest their money in financial institutions and trust banks and are more willing to sit through crises without making rash and impulsive decisions that may cause serious damage to the economic health of their nation. It allows nations to trust one another, and allocate resources towards finding the best ways to maximize income to their countries, without having to deal with hitches or economic malpractice along the way. King asserts that if there is no trust in an economy, they falter and that when economic participants trust one another, the economy runs more smoothly, and allows for more growth, combating against stagnation and ultimately benefiting the collective of a society.

Works Cited

King, Stephen D. When the Money Runs out: the End of Western Affluence. Yale University Press, 2018.

Bjørnskov, Christian. “How Does Social Trust Affect Economic Growth?” Southern Economic Journal, vol. 78, no. 4, 2012, pp. 1346–1368. JSTOR, www.jstor.org/stable/41638856. Accessed 28 May 2021.

Knack, Stephen, and Paul J. Zak. “Building Trust: Public Policy, Interpersonal Trust, and Economic Development.” SSRN Electronic Journal, 2002, doi:10.2139/ssrn.304640.

[1] King, When the Money Runs Out, 122 [2] Knack, Stephen, and Paul J. Zak. Building Trust: Public Policy, Interpersonal Trust, and Economic Development. 2 [3] King, When the Money Runs Out, 150 [4] King, When the Money Runs Out, 126 [5] King, When the Money Runs Out, 127 [6] King, When the Money Runs Out, 137 [7] Bjørnskov, Christian. “How Does Social Trust Affect Economic Growth?” Southern Economic Journal, vol. 78, no. 4, 2012, pp. 1346–1368