In The New York Times of October 11th , right next to the article on the latest Nobel Prize winners in economics, is another titled Expansive Role for Greenspan Brings Out Critics of Fed’s Chief. The article recounts how Alan Greenspan has been called upon (and has eagerly consented) to provide an opinion and a policy prescription on nearly every issue, from monetary policy to tax policy to regulatory policy to trade policy to Treasury debt management policy to California’s energy policy to airline bailout policy to . . . well, you-name-it policy.
Yes. And it’s ridiculous — when it’s not outright dangerous. Overcoming the market cacophony is the Maestro. What set of ideas fosters such a sweeping policy role for the Chairman? Those embodied in the market failure doctrine and its related dogma that government intervention is the solution. On the same newspaper page we see an article heralding the economists who make Greenspan possible — and one suggesting how troubling it is that one man seems to be amassing so much (and arbitrary) state power.
In arguing their theme of market failure — and codifying it in policy — this year’s laureates gleefully point to those economists, ostensibly their opponents, who claim that perfection in markets requires each participant to be omniscient or at least to be as informed and as smart as others they trade with. The imperfectionists think they’re answering the perfectionists. Not so. All we’re seeing is one false theory of markets (perfection, based on arbitrary premises11 ) serving as a foil for another false theory (the imperfection of markets). Caught in the crosshairs of this false alternative is the freedom required by real markets and actual market-makers — freedom that’s indispensable to a prosperous, flourishing economy.
The fact is, just as laissez-faire capitalism produces the goods efficiently and abundantly, it also produces the information that helps circulate those goods. And the information produced by a free market, with its bottom-line emphasis on reputation and results, is also efficiently and abundantly produced. In contrast, history shows that government-mandated exchanges of goods and information cause dead-weight losses, create a false sense of security and foster the dissemination of irrelevant or else misleading information.12
A free market for goods and information doesn’t mean everyone has the same information. Such a requirement is impossible. Indeed, it is in the very nature of markets that there is asymmetric information. This is hardly a problem, let alone a problem to be solved by government mandates.
The essence of markets, beyond the necessity of private property, is the division and specialization of labor. From the time Adam Smith wrote the first great (and free-market) economic treatise in 1776 13 until today, this essential market feature has been the source of all great gains in productivity, living standards, profits and investment portfolios. But the work of this year’s Nobel winners represents a wholesale assault on the principle of the division and specialization of labor. More accurately, it’s a body of work that dimly recognizes that such a principle exists, then deliberately claims it to be a destructive principle, one that makes markets go awry — and one that demands a socialist remedy. This is how policy is influenced by academia; this is how professors in seemingly detached Ivory Towers launch missiles at markets and portfolios.
Ideally, Nobel prizes should be awarded to scientists who advance the state of knowledge in their field. Economics is the science of wealth creation. Wealth is created in free markets. An economic scientist, one worthy of the name, should be able to explain how markets work. He should be able to derive, identify and apply the crucial principles driving market behavior. He should be able to recognize which principles and policies promote the production of wealth and which retard it. Among the principles promoting wealth-creation is the division and specialization of labor. To misidentify the role of this principle — or worse, to transform it from a virtue into a vice and proceed to recommend government policies which only impede and retard its operation — is to strike at the very core of the science. With all due respect, this year’s Nobel winners in economics have not engaged in science at all; at best they have engaged in voodoo.
In the field of finance and investments a similar trend is emerging, in which attention and prizes are being given to advocates of behavioral finance and behavioral economics, each of which claim that markets are inherently irrational and that there are no clear, repeatable patterns in economic or stock market history. In essence, the behavioralists are denying that science even pertains to the field of economics or investments.
Why should this matter to investors? Because this stuff is considered science today — real cutting-edge research — and because it tends to seep gradually into government policy, which in turn affects portfolios. When such teachings get the Nobel stamp of approval, policy-makers pay attention. Future students aim their studies in the market perfection direction. So expect such voodoo to continue making inroads in graduate school — and government policy. To the extent it does, expect policies that are anti-market and wealth-retarding. On the other hand, to the extent it’s ignored — or discarded onto the growing heap of past socialist nostrums — expect better results from policy and better portfolio returns.
But wait. There’s also foreign policy. It also influences (for good or ill) the status of portfolios — and skyscrapers. For example, a foreign policy that appeases and emboldens a nation’s sworn enemies and leaves its domestic innocents exposed to harm can have disastrous consequences for firms and investors trying to prosper in that nation. Surely the events of the past month illustrate the point. A wealth-protecting and wealth-enhancing foreign policy doesn’t seek coalitions with terrorist nations, nor does it sponsor and fund organizations that sponsor terrorist nations. Yet that precisely has been the policy of the U.S. in Middle East for decades and U.S. policy toward the U.N. — recent winner of the Nobel Peace Prize.14
The U.N. sponsors terrorist nations; and the U.S. is the main sponsor of the U.N. The U.N. includes in its membership the seven countries that the U.S. State Department describes (on its own web-site) as terrorist-sponsoring nations. On the same newspaper page we see an article heralding the economists who make Greenspan possible — and one suggesting how troubling it is that one man seems to be amassing so much (and arbitrary) state power terrorist-sponsoring nations. Yet the U.N. wins the Nobel Peace Prize. Last summer Sudan, one African state that still sponsors a slave trade, was added to the U.N.’s Commission on Human Rights. Yet the U.N. wins the Nobel Peace Prize. Last week Syria, one of the terrorist-sponsoring states, won a seat on the U.N. Security Council, a body which votes on the international actions of the U.S. — including its actions to fight terrorism. Only Israel voted against Syria’s elevation; the U.S. abstained. Out of 177 possible votes, 160 i6yesll votes were cast — for a terrorist nation to rule on the actions of the U.S., Britain, Israel and other peaceful nations. Yet the U.N. wins the Nobel Peace Prize — for the same reason, presumably, that PLO leader Yasser Arafat, a terrorist whose group continues to have as its main goal the end of the Israeli state, won the same prize in 1993.
When prestige and honor are bestowed on scoundrels, the virtuous must suffer.
The U.N. is no more remote an institution to investors than is the Ivory Tower. The U.N. gives aid and comfort — with the aid and comfort of the U.S. — to terrorist nations that seek the destruction of the U.S. and Wall Street. Yet Mr. Bush has sought the permission of the U.N. to act in the Middle East, permission that was granted but came with restrictions attached. Thus the U.S., as it did during the Gulf War, has surrendered large elements of its sovereignty. And in his recent press conference the President said the U.N. would be the ideal institution for organizing the post-War make-up of the Afghan government. This is how foreign policy — perverted as it is — can do great harm to markets and investors.
The U.N. is no more a peace-keeping body than the recent Nobel economists are scientists. The U.N. is a war-sponsoring body, just as the market imperfectionists are sponsors of economic policies that terrorize producers (like Microsoft) and markets (like the NASDAQ).
For investors, the lessons should be clear. For good or ill, economic policy and foreign policy have a major influence on portfolio returns. Their top-down impacts usually dwarf the effects of bottom-up factors. To be successful, you have to know clearly whether to classify economic and foreign policies as bullish or bearish. You have to know the deeper source of such policies (to gauge what future policy is likely to be). And you have to know which ideas and policies are getting all the attention, the honors and the prestige — albeit undeserved.
11 The textbook theory of pure and perfect competition holds that every market should have thousands of firms and buyers, each with complete and instantaneous information, that no participant should have any influence on price-setting, that there should be no product differentiation (or advertising), that there should be no barriers to entering any industry, and that prices should always be set equal only to a firm’s marginal cost (with the result that there can be no above-average rate of profit). A passing glance at markets shows that none fit this arbitrary (and impossible) standard of perfection. But for academics, the solution is not to revise the bogus theory; it is to inflict on markets government policies to coerce them into behaving perfectly. (or more perfectly). This is the basis for antitrust policy, price controls and an array of other market-smashing policies.
12 One example familiar to investors is the SEC’s requirement that every public company in the U.S. issue 10-Ks and 10-Qs. More than 90% of such material is never read by anyone — and costs firms billions in senseless compliance costs. Meanwhile, the implementation in October 2000 of the SEC’s Regulation FD (Full Disclosure) has caused corporate managers (who wish to avoid lawsuits) to become less specific and less forthcoming in their estimates about the future prospects of their firms. 13 Smith, considered the father of economics, wrote An Inquiry Into the Nature and Causes of the Wealth of Nations in 1776. 14 See Serge Schemann, Nobel Prize is Awarded to Annan and U.N., The New York Times, October 13, 2001, p. A1.