46 EMOTION IS BAD FOR BUSINESS

In book four Smith talks about political economy or the ability, ‘to enrich both the people and the sovereign’. Although he never refers to it as such, Smith goes on to explain the perils of fear and greed, and how corrosive both can be to economic prosperity.

DEFINING IDEA…

If your desires be endless, your cares and fears will be so too.

~ THOMAS FULLER, HISTORIAN

In their lust for gold and silver, the Spanish plundered Peru and Brazil in the fifteenth century, believing the wealth would make Spain strong and prosperous. But, as Smith points out they, ‘did not consider that the value of those metals has arisen chiefly from their scarcity’. In other words, Spain shot themselves in the foot because their determination to find gold created an over-supply and diminished its value.

By taking vast quantities of gold back to Spain, the plunderers created ‘hyper-inflation’, where prices increase rapidly as the currency loses its value. As recently as 1979, at least seven countries had an annual inflation rate of above 50% and more than sixty countries, including the UK and the US, had inflation in double digits. Today only a few countries have an inflation rate above 10%. Zimbabwe is the only one with hyper-inflation rendering the currency next to useless. In August 2008 the Z$100 billion dollar note was worth less than 8p.

Central banks may have the power to print more money when necessary, but as history will attest, creating it out of thin air (or shipping it in from the other side of the world) serves only to devalue the existing currency and destabilise the economy.

Deflation isn’t much better and is largely blamed for the Great Depression of the 1930s. A ‘deflationary spiral’ means falling prices lead to less production, lower wages and further drops in price, thus creating a vicious circle.

Often it’s fear or greed that creates these vicious circles, with economic instruments powerless to stop them. Take Mr Hotdog owner, for example. He’s got a thriving business: he’s committed to marketing, buys the freshest rolls, best-quality meat and always provides a mouth-watering array of condiments. So, he decides to expand, but is convinced by his economist son that it’s the worst possible time and he should instead batten down the hatches, cut back on expenses and ride out the recession. The father takes his son’s advice and no longer buys the freshest rolls; he cuts back on his marketing and his condiments, and buys poorer-quality meat. Sure enough, business falls away. Only the business didn’t suffer because of the economy, it suffered because he panicked and changed a winning formula.

Fiscal policy is one thing, but it’s emotion, especially fear and greed, coupled with the business cycle that can make or break an economy.

HERE’S AN IDEA FOR YOU…

Battening down the hatches during financial difficulties can make a bad situation worse. If you’re in business, the natural reaction is to cut back on spending and marketing is often the first to go. Marketing should never be sacrificed under any economic conditions. Business can’t survive unless it makes a sale. Instead, realise that most other businesses will retreat, leaving Swiss-cheese style holes in your market that a smart business person can take advantage of.