Wednesday, July 28, 2010

All I ever needed to know about economics I learned from my mother. . .

Okay, that's not quite true. Mom teach me about marginal utility, marginal revenue product, price elasticity, gross domestic product or negative externalities. However, lately I've been thinking about how some of our mother's traditional advice rings true in the economic world.

For example, even if you are as old as me, you recall your teenage days. When mom wanted you to avoid some stupid, but popular behavior that "everyone" was doing, she'd quip, "What if everyone jumped off a cliff? Would you do it, too?"

You must admit, we could have avoided the recent economic crisis if more of us had taken mom's advice and not participated in the "irrational exuberance" in the housing market. "Everyone" was making money flipping homes, building housing developments, taking and making unwise loans, purchasing homes they couldn't afford. So, too many of us joined "everyone" in jumping off that proverbial economic cliff. And here we are struggling as housing market and the economy slowly right themselves.

In the midst of the craziness, I heard one local realtor remark, "Why does everyone want to buy high and sell low?" Yeah, when you follow the crowd you often find a recipe for losing money. Most financial planners will tell you to avoid investments where "everyone" participates. These frenzies create bubbles which eventually collapse. Of course, right now the "smart" money is buying up homes/lots for pennies on the dollar (low) to sell when prices rise once more (they will). In the words of Warren Buffet, "Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it."

Yes, Mom's advice applies to the economy not just bad behavior. Level-headed thinking rather blindly following the crowd can save individuals (and the whole economy) from diving off a financial precipice. Thanks, Mom.

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