Wednesday, November 10, 2010

Quiggin does the zombie.

Firstly I'd like to thank you for the conciseness of your piece in the Sydney Morning Herald, unfortunately I might not be able to be as concise as the errors in that piece require a great deal of debunking. My appologies.

The idea that the financial markets always make better decisions than governments is wrong (and irrelevant) but it has nothing to do with "imputing wisdom to the rich and powerful" or the efficient market hypothesis. Government in most countries (including the USA) is made up of the rich and in all countries of the powerful. The financial markets on the other hand are to a great extent made up of the middle class and the people who handle their money. If anything you impute far more wisdom to the rich and powerful than the EMH. The efficient market hypothesis is states that it is impossible to beat the market because the market always correctly incorporates and reflects all relevant information. This is saying much more than that the market can beat the government, it's saying that the market beats everyone.

You might actually be thinking of the Austrian School theories that say that "financial [and other] markets always make better judgements than governments", but I doubt you've heard of the Austrian School as it's criticisms of the EMH were not made "in the wake of the crisis" many years before. In fact it is theorectically possible for governments to make decisions that, on occasion, are better than that of markets, it's just not possible for them to make them consistently enough to deliver a net benefit because the information provided by a price mechanism. Look up "economic calculation problem" on wikipedia, it will give you the outline. It may sound patronising to tell a professional economist that he needs to look up wikipedia for basic facts but I can't help that, you do.

It should be noted that you more correctly summerise the EMH further down in your article, which makes it seem like either you're being deliberately deceptive about what it says or you're simply not putting any thought at all what you're writting. If you're going to construct a strawman you should avoid actually stating it's full implications.

Your claim that economic rationalism was the "dominant ideology of the time" is absurd. Throughout the period you discuss the dominant ideology of all Western nations called for a powerful central bank, tarriffs, minimum wage laws, restrictions of nonabusive and consensual child labour, medical. legal and countless other types of professional licensing and so on and so on. The fact that this ideology was dominant is demonstrated by the facts that it dominated (i.e. it's ideas were implemented) and made it's domination seen natural. If you can find any evidence that for instance the idea that we didn't need a central bank was "dominant" at any point during the last 100 years I will recant this. Or if anyone can read aloud all the regulations applicable to financial markets is less than an hour. Please don't try this yourself, Basel II might make your tounge explode (251 pages of just the INTERNATIONAL regulations, thousands more of national and god knows how much state).

Of course the EMT was indeed used to support this "dominant ideology" in that it supported the idea that there wasn't a central-bank-created bubble and that indeed there couldn't be. But this idea is directly opposite to what "economic rationalism" says about bubbles in general and the bubbles you talk about in particular. The "reforms" after the dotcom fiasco were no doubt an overreaction, reforms made is such circumstances always are, but they were also an underreaction. The main cause of the dotcom bubble was the central bank, that is to say government intervention in the market, which has been the cause of all financial bubbles that don't involve tulips.

Of course if the EMH was right then there wouldn't have been a bubble nothing would be overpriced and therefore Julian Robertson would not have been right to bet they were. He was doing exactly the opposite of what EMH said he should. That he failed doesn't mean it's right (it's not as the subsequent collapse shows), but that you don't understand what it says about investing says you're wrong. Not just about what you say but the idea that you are well-informed enough to comment at all.

Of course you made the usual claim that "booms and busts ... can only be curbed by external regulation" despite the comprehensive failure of regulation to do anything of the kind. There are thousands of pages of regulations and god knows how many pages of decisions by bureaucrats about how they are to be interpreted, is there any evidence that they work? In fact there is good reason to believe that they will never will and I've laid out the arguments in my blog post "Systematic risk, markets and the State". Simply put government regulations don't control the booms and busts they are part of it. Regulations alternatively cripple markets when they are not needed and spur them on at the worst possible time. The simplest way to reduce booms and busts is to simply eliminate the central bank, which is known to have caused this and all previous (non-tulip) booms and subsequent busts.

There is considerable reason to believe the investment decisions generated by private firms, which are under less pressure to produce short term returns than government, will outperfom those governments. Governments have no incentive to produce value, only to reward interest groups. The government has no shareholders to satisfy, only voters, who practice "rational ignorance" about their policies, and who even if they didn't, would have no reason to systematically advance policies that are for the general good. Private firms on the other hand have people with large interests in whether or not they're creating value and for whom ignorance is therefore not rational. While some of these shareholders may value short term gains, they know that sacrificing the long term interests of the company devalues the shares right now as long term investors will not want them, nor will short term investors who plan to sell to long term investors later on.

Of course this has nothing to do with "the case for comprehensive privatisation" since that case depends on the people benefitting from selling the assets, not the financial markets benefitting (at least that's not ostensibly why it's being sought). The idea that there are bubbles and that assets sometimes getting enormously overvalued is in fact damn good evidence for privatisation, comprehensive or otherwise, properly timed. As I said to my father, you were against selling Telstra shares, I was against buying them, who was right? Not only will privatisation during a bubble benefit financially benefit the government and therefore you no doubt believe the people, but it will extract money from the bubble preventing the enormous new bad investments that often occur during them. Everyone's a winner. Of course this depends on governments investing at the correct time, but if you're right that should be easy. It's startling that you don't even get the implications of your own theories right.

I am unable to tell who you thought would be convinced by your article. The things you support are already the opinions of the unthinking majority, so it can't be them. Anyone who does the least bit of research would see the flaws in your piece so obviously they're not it's target. I can only assume that you wish to give people with no economic knowledge an excuse to believe as they do.

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