Monday, 23 May 2011

GUEST POST: The humility of non-central planning, and vice versa

Guest post by Vedran Vuk of Casey Research’s ‘Daily Dispatch.’.

In my article last week, I pointed out a failing of some very smart people, such as Ben Bernanke. As a result of their superior intelligence, many lack humility and delude themselves into thinking the economy can be centrally planned through a series of equations.

In response, a reader sent in the following remark:

"[It is] all a matter of one-upsmanship. You point out the failings of ‘smart’ people, thereby making yourself even smarter than they are. Just another ego conflict..."

It seems like a good point, but let me clarify why this is wrong. In my opinion, neither Bernanke nor anyone else can centrally plan the economy. I'm not making the claim that I can centrally plan it better. Well, isn't the free-market a central plan? No, it isn't.

Adherents of the free-market system assert that millions of individuals following their own plans will come up with better economic decisions than small committees in government offices. A belief in the free market necessarily requires a more humble understanding of one's own capabilities. It is a confidence in the plans of others, not one's own plans for them.

This viewpoint is the complete opposite of thinking oneself smarter than everyone else. It is admitting that one is not smarter than the entire economy.

Furthermore, most Daily Dispatch readers know my respect for the marketplace. In my opinion, we don't live in a world where profits can be picked like low-hanging fruit. Markets are fairly efficient, with intense competition. I've pointed this out in past issues (March 8th issue introduction). For every good investment idea, one must a find a reason to explain why every other highly intelligent market participant doesn't see it. The marketplace is filled with participants far more intelligent than me. Anyone who believes himself consistently smarter than the whole market is either a fool or delusional. Such beliefs are a recipe for disaster.

As one of my favorite quotes goes,

"The job of the stock market is to take the smartest people in the world and smash their faces into the pavement on a regular basis."

The fields of economics and finance necessarily require humility.

So, is there an "ego conflict" here? Well, I admit my inability to plan the lives of millions, and I'm not smarter than the whole marketplace. Furthermore, I'm probably not smarter than Bernanke, but I do have more respect for the complexity of the market and the limitations of my own capabilities. And that gives me an edge in my analysis that I think Bernanke lacks.


  1. Mr Vuk said...
    Markets are fairly efficient, with intense competition.

    Now, Mr Vuk makes another mistake again. The market is never in equilibrium. It never has and never will. Market equilibrium means market efficiency (or commonly called by the finance theorists as EMH - Efficient Market Hypothesis).

    The very nature of financial crises is caused by the inefficiency of the markets. This very factual observation in the real world throws out the EMH as bogus. For EMH to hold any validity, it assumes from the start that equilibrium exists. But unfortunately, equilibrium doesn't exist. It means that the market is never efficient. Borderline efficient? Yes, but it is never fully efficient.

    One can witness the inefficiency of the market in a small scale, which is basically the same as the large scale. On Sunday flea Market, one can observe that some items from certain stalls are sold out before the end of the day, while other stalls never sold out theirs. At the end of the day, they pack their stuff that they weren't able to sell and take them home. WHY? It was inefficient. Demand & supply didn't match or otherwise equal (i.e., equilibrium). This is the reality in the small scale, but actually it happens in the large scale as well.

    It is important to note that the concept of market efficiency or inefficiency holds no matter what an economic philosophy a system is (i.e., either Keynesian or Hayekian). This is why I think that Austrian proponents are deluded in their thinking that somehow if all world economies adopted their Austrian philosophies, then somehow market efficiencies (equilibrium) will exist (at all time).

    I'm for Austrian philosophies & a Hayekian supporter; however I’m not deluded to think that everything will be efficient in the market if we all follow Austrian.

    To understand what Haykian said about system self-organize is to mean that the system itself transforms from one phase (state) to another phase (different state). Self-organization takes place whether it is a Keynesian or Hayekian. It is a property of any complex system to self organizes and the reason for that is it (system) wants to find a stable point (or region) to rest. Once that point or region becomes unstable over time, then it transition to another point. It keeps moving and not stays in the same point (or region) at all time.

    Physicists called this SOC (self-organized-critically). It is only in recent years that SOC has started appearing in some economics researches. What I believe is that an Austrian or Hayekian type economic will be better shielded from severe crises compared to a Keynesian system. Crises will still occur because economy is a system and it undergoes self-organization all the time because it is an intrinsic property of a complex system.

  2. PC, my first post disappeared.

    Does any commentator here find his/her posts disappear for no reason?

  3. @FF: Once again you are attacking a straw man.

    Just as Mr Vuk was not praising the equilibrium model (in fact, the very phrase you quoted last week came from a central passage in which he ridiculed it), so too you will find here that Mr Vuk is not praising the Efficient Markets Hypothesis--instead he is saying that because the market is NOT fully efficient, (but is completely "asymettric") arbitrage opportunities will always exist, and entrepreneurs will always be able to exploit a unique angle.

    In fact, Austrians in general are not advocates of the Efficient Markets Hypothesis at all--in fact (once again) quite the opposite.

    "According to the Austrian school, [says one of its advocates] profit opportunities always exist somewhere, no less in the financial markets, because in a constantly changing world prices can never all converge to their equilibrium values. However, [modern advocates of the Efficient Markets Hypothesis] would dispute this."

    And in doing so, they make themselves laughable. So say the Austrians.

  4. So, going back to my main argument here. If Austrian proponents accept that EMH doesn't hold water (which in reality it doesn't hold water), then they must also accept that economic crises is something intrinsic to markets. It will always exist and will always be there from the fundamental fact that equilibrium doesn't exist and this is irrelevant if a system is Hyekian, Keynesian or otherwise?

    Austrian can't argue in a contradictory manner and say that crises will not occur only if we all adopt Austrian economic philosophies and at the same time admit that EMH doesn't hold water.

  5. Consider the size and damage of the crises. I think that, left to itself, the market would have fewer large crises. And I'm not sure you can necessarily call an economy an 'Austrian' or Hayekian system? Wouldn't a school of thought in economics be best considered merely as a way of analysing reality?

    Just out of interest, have you read Human Action FF?

  6. David said...
    I think that, left to itself, the market would have fewer large crises.

    David, that's exactly what I stated above. Free Markets (as in Austrian school of thoughts) with non-intervention from the state will have less frequent & less severe crises IMO compared to any other alternatives. I think that the price signal mechanism establishes itself faster to stabilize system here as compared to price distortion & confusion in a system where state intervention is a norm.

    I haven't read that book Human Action.

  7. I haven't read the following book,

    "Allen F, Gale D (2007) Understanding Financial Crises (Oxford University Press, Oxford)."

    which was referenced from another paper I read recently on financial crisis topic, "Impact of the topology of global macroeconomic network on the spreading of economic crises" (PDF pre-print is freely available - just Google for it).

    However, I found a compact bullet point summary from the author of the book, F. Allen, which shows that crises were there long before the Feds were even established. It is very important historically for those who cling to whatever economic philosophies to just take a look at the summary below, because it establishes what I've said on this thread and everywhere.

    Understanding Financial

    Crisis is intrinsic to markets and there's no way to run from it. The author/s didn't make their argument for existence of crises based on dynamical complex system theory, but the fact that they have chronicled past crises, shows that an economic system is supposed to act on its own nature, where crises (as objectivist like to call it) is simply the nature of its identity.

  8. I would like to add (in my view) that the establishment of the Feds made crises more severe and more frequent in the US.

  9. @FF: Once again, you are attacking a straw man. Austrians do not deny that crises happened before the establishment of the Fed.

    May I suggest you read what Austrians actually do say about the business cycle, instead of just guessing.

    For that, the best readings I could recommend would be:
    'Human Action' by Ludwig Von Mises, Chapters 17-20, and 31.
    'Capitalism' by George Reisman,
    pp 511-517, "Money & the Banking System,' and
    pp 938-940, "Inflation as the Cause of Depressions & Deflation."

    If you want to see an Austrian argument about crises long before the Fed, I'd suggest the book-length treatment by Charles Holt Carroll called 'The Organization of Debt into Currency'--the title of which suggests the reason for the crises.

    You might also check out the well-known nineteenth-century 'Bullionist Controversy' being argued about in Britain between the Currency School and the Banking School--the former of which Austrians are in virtually complete agreement (except for the caveats voiced by Ludwig Von Mises on page 440 of 'Human Action.')
    You can read about the 'Bullionist Controversy' in Chapters 5-7 of Murray Rothbard's 'Classical Economics.

    And if you want to see a modern Austrian treatment of pre-Fed crises, I'd suggest Murray Rothbard's very readable 'History of Money and Banking in the United States: From the Colonial Era to World War II.'

    NB: A quick Google will reveal that all the books referred to above are online in PDF form. So you've no excuse for not reading them :)


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