'Trust', 'Faith', And Macroeconomic Policy
The “Marshmallow Test” is a landmark study in child psychology which tests a toddler’s ability to delay gratification in return for the promise of a reward in the future. Those who can wait 15 minutes unattended to eat a marshmallow are rewarded with a second treat. ConvergEx's Nick Colas, however, notes that more recent work on the topic, however, shatters the notion that innate self-control defines future success. The real answer is, Colas adds, not surprisingly, trust. If the child doesn’t believe their environment to be sufficiently predictable, they will be much more likely to gobble up the first treat regardless of any promised reward for waiting. Since all investing is ultimately a game of delayed gratification, trust plays an under-appreciated role in the success of any macroeconomic policy on long term capital market and economic outcomes. What it essentially says is that you can’t keep whacking away with novel policy programs until one catches hold. Trust in the system is what keeps the population playing along. And when that trust erodes, the next iteration of confidence-boosting measures is less effective. Repeat that cycle a few times and you end up with a population that will take the first marshmallow, gobble it down, and move on.
Via ConvergEx's Nick Colas,
New York is known for, among other things, its hyper-competitive private school system. Almost before conception, parents start plotting how to get their child into the “Right” feeder kindergarten with the best record of eventual acceptance to an Ivy League school. Preferably Harvard, but Yale and Brown are acceptable outcomes as well. There is a closet industry of consultants to help complete admissions packages, train children for their interviews, and network among alumni parents to get the “Right” recommendation letters.
In my experience, most of these parents have heard about the dreaded “Marshmallow Test,” first administered at a nursery school associated with Stanford University in the early 1970s. It goes like this:
A young child – 4 years old, give or take – sits at a table with an adult researcher.
The researcher places a marshmallow or other treat on the table. He explains that he must leave the room for a few minutes.
The child is told that if he or she can wait until the researcher returns before eating the treat, they will receive a second treat as a reward.
The researcher leaves the room.
About 66% of children tested can hold out until the researcher returns, typically 15 minutes or so. It is essentially a test to see if the child has the innate self-control to delay gratification. Follow-up surveys of the children involved in the original study found that those who could wait for treat #2 had much better life outcomes. They went to better schools, got better jobs, and expressed greater satisfaction with their lives. The lesson here seems clear – either you have it (self-control), or you don’t.
Turns out the whole Marshmallow Test is deeply flawed, if not entirely wrong. A doctoral candidate in brain and cognitive sciences named Celeste Kidd happened to be working in a homeless shelter during her studies and realized that none of the children there would think twice about gobbling up the first marshmallow given their generally uncertain living conditions. A totally rational decision, that. So she and her colleagues ginned up a study that went like this:
Prior to administering the Marshmallow Test, the researcher gave the subject child some poor quality art supplies – a broken black crayon and a scrap of paper, for example. They told the child that they would return in a few minutes with some better supplies.
Sometimes the researcher returned with the promised better supplies. And sometimes they didn’t, saying that they had run out.
The children who received the better supplies as promised could hold out for 12 minutes on average before eating the first marshmallow. Those who didn’t receive the promised supplies could only hold out for three.
Turns out that the Marshmallow Test is as much a measure of how predictable the child’s home life might be, and not just an independent measure of “Will power.” Frankly, that makes a lot more sense than the first interpretation of the test, which seems to point to some innate ability to delay gratification as the key demarcation for a success adult life. If you trust your surroundings, whether you be 4 or 40, you are more likely to forgo immediate reward for a later and larger payoff.
The transition to the psychology of saving and investing is an easy one, since the choice between spending finite resources and putting them into a financial system is essentially the Marshmallow Test writ very, very large. Delayed gratification only works if you trust the system underpinning the promise of future payoffs. Works with kids in their most formative stages of life; no reason to think adults are much different, especially when it comes to emotional topics such as investing and the fear of loss.
Take, for example, the savings rates in various developed and emerging countries around the world (table above). The typical economic explanation to explain why countries like Germany have a 10% net savings rate and the U.S. is closer to 2-3% revolves around capital flows, the depth of lending markets, and other structural factors. Other interesting pairs: Sweden at 11%, Estonia 4%, and Austria at 8% and Ireland at 2%. No doubt that conventional economics explains much of these disparities.
But I can’t help but think that ‘Trust’ must play some kind of role as well. China has a phenomenal savings rate of something like 30%; the U.S. languishes well below 5%. Could it be that some combination of culture and the relative success of these two economies color the psychology of its citizens/savers? If I worked in an economy that got me off the farm and into a decent job in a city I know I’d be more likely to trust that financial system than one with 2 ferocious stock market “Corrections” over a decade and sequential stock and housing busts over the same period. Don’t get me wrong – the Chinese system has potentially fatal flaws. But as for which might engender more ‘Trust’ by virtue of success, there is room for debate.
And it its core, I think this notion of the keystone importance of “Trust” is at the heart of every logical hyper-bearish argument out there. The Bank of Japan’s move last night to super-size its Quantitative Easing program to 10% of GDP is a case in point. In the United States, the Federal Reserve’s own aggressive liquidity programs have brought huge returns to capital in the form of a double in equity values but only a muted response from the real economy. Is that how to build trust in your policies? Granted, the jury is still out and things may work out yet. Japan may get to 2% inflation, and the Fed may get its targeted 6.5% unemployment rate. But if they don’t, you’d expect the populations of these two countries to lose a lot of trust in their respective economic systems.
The revised Marshmallow Test, which measures trust and confidence, is a cautionary tale as we wind our way through the ongoing “Recovery” in the global financial system. What it essentially says is that you can’t keep whacking away with novel policy programs until one catches hold. Trust in the system is what keeps the population playing along. And when that trust erodes, the next iteration of confidence-boosting measures is less effective. Repeat that cycle a few times and you end up with a population that will take the first marshmallow, gobble it down, and move on.