The Destruction of Trust

We often take so much for granted. When we take something for granted we are often unaware of just how important it is to us. One thing we take for granted in contemporary America is the conditions that are necessary for progress, and trust is one important condition for progress that we rarely consider. We trust that others are not out to take advantage of us, we trust that the labels on the products we buy are accurate, and we trust that others recognize that their own path to wealth is to honorably serve others. As trust diminishes our prosperity vanishes.

Trust, Warren Buffet has observed “is like the air we breathe — when it's present, nobody really notices; when it's absent, everybody notices.”

Nobel laureate Kenneth Arrow has argued “that much of the economic backwardness in the world can be explained by the lack of mutual confidence.” The statistics support Arrow’s contention. Transparency International's Corruption Perceptions Index is inversely correlated with per capita GNP. Societies with a high degree of corruption—and thus low trust—are inevitably poor countries.

This strong correlation—between trust and prosperity—is succinctly explained by James Surowiecki in this excerpt from his Forbes essay “A Virtuous Cycle”.

Over time, in fact, the evolution of capitalism has been in the direction of more trust and transparency, and less self-serving behavior; not coincidentally, this evolution has brought with it greater productivity and economic growth.

That evolution, of course, has not taken place because capitalists are naturally good people. Instead, it's taken place because the benefits of trust—that is, of being trusting and of being trustworthy—are potentially immense and because a successful market system teaches people to recognize those benefits. At this point, it's been well demonstrated that flourishing economies require a healthy level of trust in the reliability and fairness of everyday transactions. If you assumed every potential deal was a rip-off or that the products you were buying were probably going to be lemons, then very little business would get done. More important, the costs of the transactions that did take place would be exorbitant, since you'd have to do enormous work to investigate each deal and you'd have to rely on the threat of legal action to enforce every contract. For an economy to prosper, what's needed is not a Pollyannaish faith that everyone else has your best interests at heart--"caveat emptor" remains an important truth--but a basic confidence in the promises and commitments that people make about their products and services.

Now here is a key point: The social norms of being trustworthy and being trusting develop over many generations, and trust can only develop in an economy when competition is the norm. Competition begets quality, transparency, integrity, respect, and trust.

When I write competition, I'm not referring to the kind of a competition that occurs under crony capitalism. Defense companies competing for Pentagon dollars is not real competition. Ethanol producers competing only because they are receiving government subsidies is not real competition. Bankers who receive bailouts and then compete against each other are engaged in crony capitalism. Competition that occurs under crony capitalism erodes trust because the public perceives the game is rigged.

The erosion of trust to the levels that are commonly seen in developing countries would be catastrophic for this country; damages from the lack of trust would take many generations to repair. Nobel laureate Friedrich Hayek sounded this alarm: “While it may not be difficult to destroy the spontaneous formations which are indispensable bases of a free civilization, it may be beyond our power deliberately to reconstruct such a civilization once these foundations are destroyed.”

Trust in the integrity of our capital markets has already eroded. Many disagree about the consequences of the Fed’s unprecedented intervention into the capital markets. Some see hyperinflation as a likely result; others predict deflation as the inevitable consequence of monetary expansion that has occurred over so many decades. Others see us muddling through, albeit with less economic growth than we would ordinarily have. My own assessment is that those who make the deflationary argument—Robert Prechter, Mish Shedlock, and Nicole Foss—are more persuasive. We can only hope that somehow we do muddle through because the consequences of either hyperinflation or a deflationary depression would be catastrophic for society. Trust would be severely crippled in either scenario.

In any case, I think it is important that you consider the possibility of a deflationary depression in the not so distant future. There are many videos on YouTube that contains talks or interviews with Robert Prechter (these are good ones: listen here and here). Mish Shedlock and Nicole Foss run economic blogs that are updated often. Recently I heard this 45 minute podcast with Nicole Foss and listening is well worth your time.

Foss argues that when there are more claims on assets than there are assets, deflation is the inevitable result. What is going on today is similar to a game of musical chairs. When the music stops there are fewer chairs then there are participants. Foss argues that those at the top of the financial pyramid will find their seats first. The inevitable consequence of this is that many Americans will find that their trust in the fairness of the economic system to be irreparably damaged.

About politicians, Foss offers a sobering perspective: No one can make what we face better but many can make it worse.

I don't know if Foss has read Hayek, but she too believes that trust, which takes a long time to build, can quickly be destroyed.

As trust is destroyed, Foss believes that repression is the inevitable result. Why? Growing number of Americans will believe the game is rigged.  Attacks on our freedom will intensify. Foss believes that the antidote for repression is decentralized, voluntary community action that is based on trust.

I’m more of an optimist than Foss. I believe that if allowed to do so, entrepreneurs will discover solutions that will prevent or mitigate the most dire scenarios. I do believe that many Americans are ready for new alternatives, yet those who have benefited by our current system of crony capitalism will not surrender their privileges easily.

Being exposed to the sobering perspectives of Precter, Foss, and Shedlock is worth your time. I know that some of you are thinking I'm depressed already about America’s future and my future and the future of my children; I don’t want to be depressed any further. Don’t let those thoughts stop you. The more we are motivated to consider the worst alternatives, the more we are motivated to take actions that will prevent the worst from happening.