A recent brief article on this issue made me think of this article below I wrote in Fall 2011, soon after listening to the audiobook version of Michael Lewis’ “Boomerang.” 

The stories and lessons learned regarding Iceland and Greece were particularly intriguing.  Trust, once again, struck me as a vital intangible being forgotten in folks’ decision-making processes. 

I often hear people question why banks are supposedly sitting on large amounts of liquidity and not lending out cash to borrowers.  Perhaps a good starting point for evaluating that premise is considering why capital holders would lend for an endeavor in the first place.

In order for an economic system to function, there must be a sufficient level of trust between the lender and borrower for the proposed transaction to occur.  More specifically, a capital holder must trust that the capital being lent will be repaid with a sufficient rate of return in order to persuade the capital holder to follow through with a proposed transaction.

No potential borrower is inherently entitled to a loan.  In fact, a poor lending decision by a capital holder makes society worse off because a failed endeavor squanders the scarce resource of capital.  Folks often believe capital is unlimited, possibly due to the illusion that the ability for a central bank to print money means that capital can be magically created out of thin air.

While I understand why people might fall prey to this illusion, the fact is true capital is not unlimited.  Printing paper money does not inherently increase the amount of actual capital in the economic system.

Until there is a sufficient level of trust between potential lenders and borrowers, there will not be an opportunity for our economic problems to be alleviated.  The issue of uncertainty in the markets is often stated as the proximate cause for the lack of capital being put to work.

If we want to minimize that uncertainty to a level which would encourage an increase in the velocity of capital lending then there must be an increase in the amount of trust between potential lenders and borrowers.  Is that possible?

I believe the answer is a resounding yes.  How to do it, however, is the tougher question to answer.  Michael Lewis does an exquisite job in his book “Boomerang,” when discussing the economic situation in Greece, of explaining that a breakdown of trust among citizens can make an economic system dysfunctional.

As one example in the book exemplifies, if citizens do not feel confident enough in their fellow citizens to say positive words about other citizens behind their back, then it is probably a good sign there is a systemic breakdown of trust.

So how does a society rebuild trust amongst its citizens?  Is it the banking system’s responsibility?  Is it the government’s responsibility?  More likely, it is everyone’s responsibility.  This discussion is not about assigning blame, it’s about proposing solutions.

The solution is for individuals to take a look in the mirror and understand what they can do to help rebuild trust.  It is understandable that folks are wary of others, and I do not propose that people blindly trust others.  However, individuals do have complete control over whether others can trust them and, therein, lies the answer.  Be trustworthy.

Related Reading: The Math of Low Trust