Why do we do dumb things?

My friend Fjordman sent me a link about Behaviorial Economics that got me thinking. This new area of study is the intersection of human psychology and economics. In economics, we assume that people will always make the rational decision.

This is proving to be a wrong assumption. The truth is that we often make irrational decisions in economics as well as in voting. Behavioral Economics also explains why people lose money in the stock market as well as vote for the wrong politician.

Let's start with the stock market. To make money, you have to buy low and sell high. To do that we have to buy when everybody else is selling and sell when everybody else is buying. But our human nature was developed in the thousands of years of living in the jungle. To survive in the jungle, we have to group together in order to aid each other.

Thus we have developed a herd instinct. This works well in the real jungle but is disastrous in the financial jungle. In a bull market, even the taxi driver has bought stocks. In a bear market, most people have sold out. Thus, while its comforting to buy when all your friends are buying, you are doing something irrational.

You end up buying high and selling low - the opposite of what you are supposed to do. Another problem with human nature is that we are all pleasure seekers and pain avoiders. That is good in most circumstances but bad when it comes to the stock market and voting at election time.

When it comes to your stock market investments, you tend to hold on to your losers and are quick to sell your winners. That's because its painful to sell stocks at a loss. We suffer anguish when we sell loss making stocks because of the hard work and sacrifice we endure to make that money. On the other hand, when we take profits we are delighted at the though our profits can make.

This is illogical. You should sell, if the prospects are no longer bright and hold so long as prospects remain good, regardless of if you are making a profit or loss. So how does all this explain our voting behavior? Well, for a start it explains the phenomenon of Barrack Obama. He is a hardly known freshman Senator from Illinois.

Yet, he is winning against Hilliary Clinton who should have won nomination by Super Tuesday. How do you explain this? I think its to do with our desire to avoid pain and to seek pleasure. If you listen to his speeches, Obama is very good at promising you everything without asking you to make any sacrifices. Are you worried about losing your jobs? Obama will renegotiate Trade Agreements (read more protectionist measures).

Do you want Socialized Medicine? Obama will provide by raising taxes. How are you going to create jobs by raising taxes and becoming protectionist? That's trying to square a circle. Obama does not say. He just promises. Raising taxes will drive away investments. If you turn protectionist, so will your trading partners.

Are you sick of the war in Iraq and at the same time fearful of terrorism? Don't worry. Obama will withdraw from Iraq and talk to America's worst enemies. He tells people that he can make America more secure by simply talking to his country's enemies. What a fairy tale he is selling
people and they believe him. More likely after withdrawal, Iraq becomes a Shiite style Taliban-land that threatens the oil supply and support terrorist groups.

Jihadist groups will be encouraged into thinking that Allah is on their side - like what happened after the Russians were driven out of Afghanistan. There will be more, not less terrorism.
Obama's popularity soared because he makes promises to give pleasure without inflcting pain.

His inexperience, on balance, actually works in his favor. While he lacks a track record to boast about he also has none for his opponents to attack. This makes it easier for people to believe him and his snake oil promises. People believe him because they want to believe that he can do all this magic for them without any pain.

A politician who tells the truth will not get elected. That is a flaw of human nature. People don't want to hear the truth if it is painful. The truth is that Americans have been spending beyond their means for many years now. Savings are at an all time low and Americans must cut down on their consumption. America faces a relentless enemy in Radical Islam and it will take years of blood, sweat and tears to win this war. But people don't want to hear that.

So you end up putting liars in office.