Politics

The Wager Behind the European Debt Crisis

In the Ancient Roman Empire, no battle, victory, change of season or important state event came to pass without a call for the blessing of the gods. Anyone who could afford the services of soothsayers embraced the chance to have their future read.

At first glance, no one would envy the soothsayer asked to predict the future of the ruling emperor; one mistake in interpreting the flight of a flock of birds, the position of the stars, or the intestines of sheep would surely mean an excruciating death. But the trick to staying alive was to predict that the ruler would live a long and fulfilling life — while the ruler lived, the prophesy was proven correct. If the ruler died prematurely, he was no longer around to hold the fortune-teller accountable for a false prediction. Herein lies the foolproof wager of the soothsayer.

Today, amid Europe’s lingering debt crisis and shell-shocked political elite, I can’t help but wonder if the same mental gamble — taken consciously or not — was responsible for the flawed creation of the eurozone.

The Story of Europe’s Debt Crisis

The aftermath of Greece’s January upset election is unfolding against a backdrop of ominous tidings from the global financial markets. A short version of the economic story behind this setting goes as follows:

In 2008, the real estate bubble burst and triggered a subprime mortgage crisis in the United States. Exposure to bad debt cascaded through U.S. and European banks and states, some of which were already heavily burdened with debt. The resulting credit crunch lowered lending and investment levels, creating what has since been coined The Great Recession. As the fires began to die down, a general consensus emerged among economists that the architects of the European project missed the ball completely on at least two counts: First, the European Central Bank was not given the ability to act as a lender of last resort, as any other central bank does. Second, no currency union can withstand financial storms without a fiscal union.

An intricate political drama unfolded alongside this downward economic spiral as numerous leaders offered their opinions of what exactly caused the crisis and how it could be solved. The sound bites from the Reinventing Europe conference held in October 2013 to address the Continent’s problems provide a stunning snapshot of how, five years after the economic crisis hit, the opinions of the Continent’s best and brightest were still all over the map. Jacques Delors, the former president of the European Commission, blamed European leaders for the crisis, saying that they were better at putting out fires than building a sound organizational structure. Former French President Valery Giscard d’Estaing disagreed, arguing that the EU foundations were sound and the real problem was members’ failure to adhere to the Stability Pact, while former Spanish Prime Minister Felipe Gonzales pointed to the bloc’s inability to make necessary reforms. The list of potential culprits ranged far and wide, as did proposals for solutions, which included everything from strengthening Europe’s economic might, changing the bloc’s requirement for unanimous decisions, introducing a federal political structure to the organization, and addressing immigration issues.

Even with five years of hindsight, leaders could not reach an agreement on what had happened and what needed to be done to fix the flaws in the European Union’s structure. How is this possible?

The Forgotten Factor: Ancient Brains in a Modern World

Human nature is the central factor underpinning the European debt crisis, but it is often overlooked. The human brain is ancient in design, and is not fit to deal with the complexities of the issues in today’s world. Though we ignore these limitations at our own peril, we do so precisely because our ability to perceive these limits is limited.

The observation that there is a large gap between the problems the human mind tackles today and the problems it was hard-wired to solve during the last 6 million years of evolution is widely accepted. However, it is my belief that the consequences of this mismatch are still massively underestimated, in part because they are so enormously large that they are difficult to fathom, and in part because our brains are not adept at accepting and working with unknown and unknowable unknowns.

A simple way to think about this is to compare it to the idea of dark matter. Physicists claim that even with the strongest telescopes and the most sophisticated sensors, we can only observe and explain about 20 percent of all matter in the universe. The rest is hidden somewhere, somehow, in a way that we can only detect indirectly because it does not emit light or any other form of energy. The same is true in cognitive science: Our brains are tailored to interact with and respond to the very small part of the physical world in which we have evolved, no more, no less. The rest of the world remains outside the realm of our experience. For the sake of simplicity, I will call this “dark blindness,” or the idea that humans are not biologically equipped to sense or make reasoned judgments about the majority of the physical world around them, even if it directly influences their actions or mental processes.

Just as dark matter reveals itself indirectly by influencing observable objects like stars and galaxies, dark blindness shows itself in seemingly bizarre and irrational behavior. Some of this behavior we can recognize in ourselves, in the way we tend to ignore negative but obvious situations (the “Ostrich effect”). Some is harder to spot, such as our tendency to reject new evidence that contradicts our beliefs (the “Semmelweis reflex”). The Ostrich effect and the Semmelweis reflex are just two of over 200 cognitive biases, or systematic errors in judgment, that have historically served us well in the evolutionary struggle for the survival of the fittest. However, they have also led to shortcomings in the present modern world. This does not mean that we are right or wrong, smart or stupid, it simply means that as we have evolved, we have become hardwired to act intuitively in certain ways in particular situations, without needing to fully comprehend the environment we face. (Richard Heuer’s Psychology of Intelligence Analysis, a required reading for all Stratfor analysts, explores the cognitive biases that are especially relevant for intelligence professionals.)

The key difference between dark matter and dark blindness is this: The choice whether to believe in dark matter will not affect a person’s daily life or the inner workings of a state, while being unaware of or choosing to ignore dark blindness in today’s world can be disastrous. Let me explain what I mean.

The hunter-gatherer had only to understand the part of the world that determined his immediate survival — a part that the human brain became hardwired to understand. But the modern human has stepped outside of that realm, beyond the basic role evolution prepared us for. We now need to understand a growing portion of the “alien” world that we were never biologically equipped to handle. For example, hunter-gatherers had a rudimentary but highly effective understanding of statistics that placed priority on recent information as opposed to events in the distant past. This worked very well for avoiding encounters with wild bears — if you see a wild bear in a given location, it is very likely that you will see it in the vicinity a short time later. However, this specialized instinct is less appropriate in today’s world. The eurozone’s creators assumed that because it worked well in its first few years of existence, it would likely continue to work well in the future, regardless of the fact that such an outcome would be statistically unlikely given its known structural issues.

The Unknown Unknowns

As if our natural cognitive biases weren’t damaging enough to our performance in the modern environment, there is a deeper problem to consider — some of those biases make it difficult for us to accept that they hurt our abilities or even exist in the first place. The Dunning-Kruger effect, for example, explains how those lacking competence do not realize they are incompetent because they do not have the skills to sense the difference between competence and incompetence. For the hunter-gatherer, this problem never existed because all survival skills were relatively equal across the population; incompetence could not exist without specialization, so the brain did not evolve to detect it. As we have moved into a cognitive territory that we have no natural competence for, we also have been left with few skills for recognizing or understanding it. In short, we lack the competence to realize that we are unable to grasp the world modernity has brought us.

Even our greatest leaders are not exempt from this; they are simply the dark blind leading the dark blind. The complexity of today’s vast array of European structures is just as bewildering to us as the Roman state was to its people, and our patterns of coping with that stress have remained relatively unchanged over the past 2,000 years. Our reasoning still suffers from the same aberrations because the human brain’s circuitry has not been able to evolve apace with our environment. Eurocrats, lawyers, sociologists and economists fill the European institutions, but they are ultimately led by politicians. And they are all, as the Nobel prize-winning Paul Krugman would say, very serious people. And very serious people make very serious mistakes.

These leaders made critical errors while establishing the eurozone. Everyone knew that some countries did not really meet the criteria for membership in 1999; everyone could see that nearly every member had violated at least one financial constraint with impunity by 2005. And when Greece finally acknowledged in 2009 that it had cooked its books for years, nobody was surprised. And yet nearly everyone was surprised when confidence in the financial markets plummeted, putting the euro in jeopardy. The founding heads of state had good reasons for establishing the eurozone and were able to agree on the construction of a currency union, but they could find little common ground on settling the details of a fiscal union. Instead, yielding to their own Ostrich effects, they chose to downplay the fatal imbalance in their plans and forge ahead, ensuring that the bloc’s design was flawed from the beginning. But like the Roman soothsayers of old, what financial expert would have strongly advised ruling politicians against the creation of such a powerful European symbol? What expert would have wagered his career by contradicting his leader, when by the time the eurozone was in trouble he would be reporting to another politician? What enlightened leader could have overcome his Semmelweis reflex and allowed himself to be convinced that his belief of success was irrational? And so the age-old and all-too-human tendency to make choices on instinct, in matters we do not fully grasp — and despite many warning signs — persists.

We Cannot Learn the Unlearnable

The creation of the eurozone was one of the grandest projects in recent history. It was initiated, executed and managed by the best of the best. The first five years of its existence proved its founding fathers right. Then the Great Recession came, and hindsight kicked in. The current generation of leaders rushed to put out the fires, and though the flames now seem to be under control, the water damage is substantial and it remains to be seen whether the embers will reignite again.

Meanwhile, practioners of modern evolutionary psychology document the use of stop-gap measures and finger-pointing, rather than advocating the thorough architectural redesign that is needed. We acknowledge the failure’s psychological roots, noting in the margins that we have done nothing of substance to stop history from repeating itself again.

The Wager Behind the European Debt Crisis is republished with permission of Stratfor.”

The Wager Behind the European Debt Crisis

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