Thursday, 14 May 2009

Self-Delusion, Here We Go Again

Many economist spent the years before the current crisis in utter frustration. They saw their bit of the world being upside down, valuations being all over the place, and their arguments being not heard by the markets. "Hey! You gloomy guy! Shut up! If you were right, the markets would have reacted! Have you heard of efficient markets?" And thus the markets pointed at themselves as the justification for their own valuation. "This asset's value is here because we think so. Don't come to us with this shadows -in-the-cave story. That's so last millennium." (OK, millennia.)

This is why it is such an entertainment to watch the global financial markets talk themselves into exactly the same trap. "The end of the fall is here because the prices go up. The evidence is that the prices go up." And we see the analysts modelling the fundamentals scratching the wall in frustration, again, as they try to point out how meaningless the markets' very recent moves are.

Here is an example from the FT:

Traders pointed to China, which yesterday revealed a large increase in raw materials imports, reflecting in part the economic recovery but also Beijing's attempt to take advantage of lower prices to stockpile commodities. Iron ore and copper imports reached a record high last month, while crude oil imports hit their second best month at the same time.

Other analysts said supply and demand fundamentals were still weak, even taking into account China's swelling imports, and said that speculative money was the main reason behind the rally.

"Recent price strength is not based on fundamentals, but on financial flows," said Mike Wittner, oil analyst at Société Générale in London. He said investors' appetite for riskier assets such as commodities was "better entrenched, and more sustainable" than earlier this year.

That't it. "Recent price strength is not based on fundamentals, but on financial flows." Oh, how well I know this song!


  1. The trouble with your argument is that the principle of efficient markets works about market inefficiencies as well. The term 'efficient market' essentially refers to a mechanism and not a theory. Then the only questions is whether the mechanism is there. If it is, then the game is over.

  2. Well the big question would then be to what extent the markets crash was based on financial flows rather than fundamentals.

  3. Yes, that is the big question. It seems that the range of Ultimate Cause for this crisis, as put forward by the member of the Amalgamated Union of Professional Thinking Persons is even wider than that of the forecasts...

    Most mainstream economists seem to believe in the 'financial ripple' theory, which is tempting, for it does allow the comfort of staying in the warm and cosy modelling framework. The trouble with it is that it does not really work, apart from the nice feeling the familiarity provides. There are too many unexplained phenomena poking out. Why did none of the policy answers - prescribed by the theory - work for so long? That's perhaps the number 1 one.

    One easily ends up with the suspicion that the darkness around us is not due to the lack of sunshine but rather it is the sand into which our heads are stuck in.