Eurozone must work to recapture markets’ emotions

THE eurozone debt crisis may be as much about the heart as it is about the head — like a jilted lover, markets are just finding it hard to trust again.

Behavioural economists say financial bubbles can create an emotional high that turns into a irrationally deep low when the bubble pops — people ignore fundamentals and have only negative associations with certain investments.

“Something like that is now happening with the euro (zone) where it has become contaminated on a psychological level and hated,” says David Tuckett, psychoanalyst and author of Minding the Markets. “It actually is quite a good analogy to think of if your girlfriend has an affair. It’s actually very difficult to get back (together), although it can be done.”

Tuckett and other proponents of “emotional finance” (the intersection of managerial finance and investor psychology) say in periods of crisis following sustained growth, fear and panic can spread like a virus. In the case of the euro, the prospect of Greek default was enough to take Greece’s debt problems off years of slow boil and prompt Europe to think the unthinkable — breaking up the eurozone.

To emotional finance experts this makes sense; like the example of the troubled relationship, at a certain point everything associated with a former love seems tainted.

Emotions are a way people can tip the scales in a dilemma between two unknowns, and changes in these emotional states drive events like the eurozone crisis, says Tuckett. “In order to make decisions in a world of uncertainty, if it’s falling in love with something or making a big investment or buying a house, your emotions have to be engaged in that decision because it cannot be done on rational grounds alone.”

According to psychologists, the brain’s emotional workings can be divided up into three systems: Wanting, attachment and anxiety.

Wanting is what psychologist Sigmund Freud called the pleasure principle, and is reinforced by producing the neurotransmitter, dopamine, a highly addictive chemical.

Attachment produces oxytocin, associated with the pleasure received from being part of a relationship, even fleeting ones. Tuckett says this same type of attachment pleasure is derived by holding onto investments and decisions.

Paul de Grauwe, professor of international economics at the University of Leuven, says: “There was euphoria about the eurozone like there was during the bubble in the 1990s — people didn’t see the weaknesses. When you are euphoric you are blind. It’s like being in love — you are blind.”

The anxiety that unpredictability and uncertainty produces is not appreciated fully enough, says Richard Taffler, a professor of finance and accounting at Warwick Business School.

When investors lose confidence in their ability to know market direction, they turn negative and stop believing in their data, he says.

“It’s a cauldron of emotions we’re dealing with — we’re saying the markets want this or that or borrowing rates are this or that, but fundamentally it’s all about anxiety and lack of trust.”

Professor of psychology at City University London, Peter Ayton, says this has been deemed the ostrich effect — investors bury their heads ignoring fundamentals and just go on emotion. “You don’t want to look when you know that the news is probably bad ... It’s not that you don’t even sell or trade, you just don’t look at what’s happening.”

The idea of waves and fears dictating market behaviour is nothing new.

John Maynard Keynes wrote about animal spirits of optimism and pessimism and Friedrich Hayek wrote in 1945 of the marvel of a market that enabled disparate groups of investors to make correct actions based on limited data.

“It’s a combination of animal spirits that you will find everywhere, and a combination of structural weakness in the eurozone that makes governments very much like banks,” says de Grauwe.

One senior economist, who asked not to be named, says the only sure way to stop the virus was for governments — and the ECB — to take decisive action. “The most serious source of contagion is [the lack of] policy responses. Unless you have a very immediate and clear line, it can fester for some time.”

— Reuters