Comments (77)

• ktibuk

  "while on the other hand, many biologists would recognize that Richard Dawkins goes too far when he thinks that the theory of evolution by itself virtually disproves the existence of God."

  Dawkins doesn't claim evolution disproves the existence of God. He just claims evolution disproves the existence of the god of Abraham. Just like discovery of the North Pole disproves the existence of Santa.

  Published: November 19, 2009 8:46 AM

• tms

  What about the Harry Browne Permanent Portfolios? They embrace both the Austrian school and the idea of market efficiency. Not sure how that is "hilarious".
  

  Published: November 19, 2009 9:49 AM

• Mr Eko

  ktibuk,

  I'm certain Bob added the Dawkins jab in there to get the athiests stirred up.

  It never fails.

  Published: November 19, 2009 10:09 AM

• N. Joseph Potts

  What we get from Nobel laureates: "sensible economic policy."

  If there WERE such a thing, where would we get it? From the outfit that brought us the Post Office?

  Published: November 19, 2009 10:34 AM

• K Ackermann

  This is a very weak attack against Lucas. An individual predicted the housing bubble does not disprove what Lucas was saying. Does that that mean only that individual is smart, and everyone else in the world is stupid?

  I think the existence of the bubble, and its subsequent crash sort of makes Lucas' case in a general way.

  There are more interesting ways to attack the EMH.

  To say that a broad time range for a prediction is useful contains almost zero information.

  How broad? As broad as the Quantum fund that lost huge when in shorted to tech bubble prematurely? They lost in 1999 - just a little bit off.

  Published: November 19, 2009 10:42 AM

• Alex

  Pick a market, any market – say the stock market. The EMH in weak form argues that an individual investor cannot hope (other than by being lucky) to beat the index by picking individual stocks. This is why monkeys throwing darts at stock pages typically outperform the average mutual fund manager.

  Of course, a person with access to considerable resources (e.g., insiders of firms) can receive news and process the effect of such news on individual stocks faster than the average person and can thus beat the index by their individual stock picks.

  It strikes me that these are useful things for the average individual investor to understand when investing. Hence the above EMH notions are useful.

  I think, though, that when EMH proponents try and argue that no one can have a better theory about the right price of an asset or group of assets (e.g., stock prices in general) than the average market participant, this is nonsense.
  

  Published: November 19, 2009 11:01 AM

• Fed Up

  I find nothing funny about quacks spreading harmful lies and harmful dogmas and pandering to the left and to big government.

  Mainstream economists are anything but funny.

  Published: November 19, 2009 11:04 AM

• mikey

  The yield curve inverted in late 2006.Yet the Dow did not peak for another year. According to EMH, this should have happened immediately, this is the most reliable indicator there is of a coming downturn.

  Published: November 19, 2009 11:23 AM

• Peter Surda

  Great job Dr. Murphy.

  As I recently read the Black Swan, I can immediately recognise the underlying issue here. Some economic models seem to predict very well, as long as certain conditions are met. However, if these conditions aren't met, they fail spectacularly. The economists behind these models claim that such situations are anomalies so it doesn't matter.

  However, they miss the obvious: if the losses that happen during the time when it doesn't work exceed the profits from the times where it does work, then whoever applied the model is screwed. And the main reason why this happens isn't that the model is incorrect per se, but because the economists are unable to predict when the conditions will fail.

  Another way to put this is that it works on small scale but fails on big scale.

  Therefore, I tend to agree with Dr. Taleb here: it's better to be approximately right than exactly wrong.

  Published: November 19, 2009 11:25 AM

• Dave

  EMH kinda makes sense if and only if every single player in the market all had the same amount of information and any counter information and any corrobative information ad nauseum. And on top of that, everyone would have to have equal market power to affect the price as well as assign the probabliites of every outcome identically and put the same weighting on every new piece of information that may or may not affect the stock price as it arrives.

  So - yeah - works great.

  But as I'm sure most ppl on this forum would have experienced, things like the realisation that buying gold isn't a bet that it will go up but rather a hedge against the USD going down completely changes your view of the yellow worthless piece of metal that just sits there and stares at you. If you realise this before the vast majority of the market does, then yes you can outperform because you have correctly acted on the publicly available price sensitive information that has been sitting there since Nixon closed the Gold window.

  Unless that position is wrong of course.

  Published: November 19, 2009 11:32 AM

• Pussum207

  I'm inclined to think that the error (committed on all sides of the debate) is to assume that EMH necessarily implies that bubbles cannot develop or exist. It seems to me that, from a trader’s perspective, money supply in excess of demand IS a fundamental valuation factor, at least in the short/medium term.

  In that regard, if I recall correctly, I think Vernon Smith found in trading experiments that even once traders fully understood that excess liquidity caused price bubbles, the bubbles still occurred, they were just smaller and popped earlier.

  I think the bigger problem in economics is the (often implicit) assumption of homogeneous expectations. My impression is that this is often justified on the basis that the assumption of rationality plus a common set of information demands it. I don't need to tell Austrians what the flaws are with this.

  Not to defend EMH, but I would say two (or three) things.

  First, EMH does not imply that the market cannot be wrong in any given instance. It basically implies that the market price is an unbiased estimate and that it is extremely unlikely/difficult (again, not theoretically impossible) that an investor can systematically over time inhabit the upper tail of the distribution.

  Second, Austrians were undoubtedly right to predict a crash. As I understand many Austrians were however predicting a crash for a long time before it occurred. I would have thought that a conclusive demonstration that EMH has been violated would require demonstrating that following a trading rule based on Austrian economics would over a meaningful period of time allow one to earn above-market returns. This not only means identifying bubbles but reasonably consistently and reasonably accurately forecasting the specific timing of a market turn. Predicting that a single (albeit catastrophic) event will occur at some point over an unknown interval isn't enough. As I understand it, many many trading rules (such as those based on technical trading rules) have been tested and failed.

  Finally, I think that, to the extent that EMH has value, it is with respect to its implications for individual investing, not policy-making. In that respect, I think EMH is generally correct - it is very hard to consistently beat the market (although I read of a study recently that found a positive correlation between fund managers' IQ and supra-market returns). I think one of the mistakes made was using it as justification for policy-making in a specific instance, i.e., "EMH says the market's always right, therefore everything must be OK."

  Published: November 19, 2009 11:33 AM

• Lord Buzungulus, Bringer of the Purple Light

  Nassim Taleb is an arrogant fool and an ignorant blowhard. (It's interesting to note that he shares a common flaw with the proponents of radical uncertainty: an implicit rejection of marginalism.) As Hazlitt noted of Keynes, when Taleb is not horribly wrong, he's merely trivially correct.

  Here are a couple of articles cutting him down to size (warning, some foul language in the first one):

  http://www.nuclearphynance.com/Show%20Post.aspx?PostIDKey=54595

  http://www.efalken.com/papers/Taleb2.html

  Austrians would be well-advised to steer clear of this idiot; he may not like neoclassicists either, but that doesn't mean he has any kind of viable alternative.
  

  Published: November 19, 2009 11:36 AM

• Lord Buzungulus, Bringer of the Purple Light

  Pussum207:

  "I'm inclined to think that the error (committed on all sides of the debate) is to assume that EMH necessarily implies that bubbles cannot develop or exist."

  You're right; whatever its other flaws, EMH in no way says that bubbles are impossible. This has been explained to Bob many times here, so I have to wonder why he keeps implying it.

  Published: November 19, 2009 11:43 AM

• Walt D.

  " many biologists would recognize that Richard Dawkins goes too far when he thinks that the theory of evolution by itself virtually disproves the existence of God."
  
  You can explain anything by angels in heaven, and demons in hell. However, you can predict nothing.This is Dawkins point.
  
  In the UK, religion has always been intellectualized.
  UK theologians have debated such issues as how many angels can dance on a pinhead, and why God did not answer the prayers of amputees to re-grow limbs after WWI. Most of the issues of God vs Evolution were resolved over 100 years ago. The genome project has disproved many of the arguments by creation scientists. You can find all these arguments discussed ad nauseum at talk.origins. You will never get a resolution to this argument since one side sees what it believes, while the other side beleives what it sees.
  

  Published: November 19, 2009 12:14 PM

• Mushindo

  (Sigh) this goes round and round.

  At a deeply technical level, at the heart of the EMH lies a paradox worthy of Zeno.

  For the EMH to be true, market participants must all behave on the assumption that it is not true ( that is, they must either be unaware of it, or if they are, they must consider it to be false). And if market participants behave as if it is true ( ie they are aware of it and believe it), then it won't be.

  This leaves the EMH in the same sort of state as that damned cat - a superimposed live-deadness, where on the one hand, yes, the market price does indeed contain all confirmed market responses to all known information to date, but, no, it also contains other market responses to , er, animal spirits (Damn I never thought Id ever be caught quoting Keynes ...what the hell is wrong with me?). Not to mention policy intervention.

  Anyway, when EMH was first formulated and nobody else had any knowledge of it, it may have had some degree of substance to it - but it was never an iron law - its substance was inversely proportional to the degree of irrationality and false information informing market participant activity. when it became progressively well known, the initial degree of substance in the hypothesis started getting eroded, such erosion being directly proportional to the extent to which market participants let the hypothesis itself inform their decisions.

  SO, just like newly-discovered macroeconomic cause/effect relationships (remember the Phillips curve?) tend to vanish as soon as policymakers start to exploit them, so the EMH is ultimately neutralised by the very fact that it is articulated. Its rather like the bird in that rude song which disappears up its own orifice.

  (I posted this elsewhere some weeks ago, but couldn't resist pasting it here.)
  

  Published: November 19, 2009 12:15 PM

• Abhinandan Mallick

  Great article Bob, thanks for putting it up. The comment about the false comparisons made with Quantum Mechanics might just push me to write my next piece.

  Published: November 19, 2009 12:46 PM

• fundamentalist

  The really nice thing about the theory of evolution is that it predicts everything and its opposite. It's totally unfalsifiable.

  Published: November 19, 2009 1:15 PM

• pussum207

  Mushindo:

  "For the EMH to be true, market participants must all behave on the assumption that it is not true ( that is, they must either be unaware of it, or if they are, they must consider it to be false). And if market participants behave as if it is true ( ie they are aware of it and believe it), then it won't be."

  Two points.

  1) Unless, of course, market participants believe that only they have recognized this logical fact and believe that it thus opens up the field again for them because of everyone else's belief in EMH. Logical death spiral ensues...

  2) EMH doesn't say it's impossible to beat the market, just really hard and very unlikely. In any case, at least certain segments of the financial industry spend lots of money on analysis, information gathering, proprietary modelling, trying to gain an "edge", etc. This would suggest either that they don't believe in EMH or that they believe they can be amongst the few that can beat the market.

  Published: November 19, 2009 1:15 PM

• Walt D.

  The EMH says that bubbles can't occur? To paraphrase Mr. Bumble -"If the EMH says that, then the EMF is an ass, a idiot".
  Austrian Theory not only forecast the housing bubble, but explained what was causing it. While Robert Blumen and others at this site brought this to everyones attention 5 years ago, EMH can not explain the phenomenon, even with 20/20 hindsight. This should convince anyone that EMH is a worthless concept.

  Published: November 19, 2009 1:19 PM

• Fed Up

  Fundamentalist,

  Everytime I go at wal-mart I know that evolution is false and that the opposite of evolution, DEVOLUTION is what's going on.

  Surely that our ancestors had to be more brillant than us and surely that our descendants will be 3 neuron slugs.

  Published: November 19, 2009 1:28 PM

• fundamentalist

  FedUp, I know you meant to be funny, but the truth is we really are devolving. The human genome is deteriorating at about 1% per generation. We won't eventually be slugs, but we will eventually be grotesque monsters.

  Published: November 19, 2009 2:03 PM

• EMH bubble

  EMH can easily allow bubbles. Let's say that company A bets "heads" on a single flip of a coin by company B. Company B uses a coin giving .99 probability of heads on an even roll of a die and a coin giving .01 probability of heads otherwise. Company A sells shares that pay $1 for a win and $0 for a loss. So the IPO is somewhere around $0.50. Company B rolls the die and it's even, so it use a coin giving .99 probability of heads. Company's A stock goes up to $0.99. Then they finally flip the coin, but it's tails! Company A loses everything, and the stock crashes to $0. So we had a coin bubble that bursted. But this was a perfectly efficient market.

  Published: November 19, 2009 2:09 PM

• david janello

  Once again, complete ignorance regarding the Efficient Market Hypothesis. From both the distinguished author of the article and the numerous respondents.

  If the EMH were false, why did very few options market makers go bankrupt last year? Or after the dot-com bust? Or in the 1987 crash?

  These market professionals routinely trade instruments with risks that are 1) unlimited 2) unknown and 3) unquantifiable. ALL of them use models based on the EMH to hedge their positions. And any market maker foolish enough to pick a market direction on the assumption that the market was 'inefficient' would be bankrupted in short order.

  EMH states that market inefficiencies are not exploitable by a RISK-FREE arbitrage.

  Austrian speculators are free to trade against real and imagined bubbles and make huge profits if they are correct. This does not violate the EMT in the least.

  Last year many hedge fund managers (your author included) followed Austrian principles and executed successful strategies targeting the housing and banking sectors.

  But these speculations require capital at risk. The EMH does not say anything about risk based capital. Thousands if not tens of thousands of investors correctly predicted the dot-com and tech bubbles. But bubble identification is trivial and of little value. What is valuable are ways to exploit this inefficiency at acceptable risk levels and at an acceptable cost. In practice, exploiting bubbles usually costs more than the potential profit in the bubble itself. Put options on dot-com stocks cost 10% a month in 2000-2001. Dot com stocks declined 10% a month so purchasers of these options broke even.

  Published: November 19, 2009 2:12 PM

• EMH bubble

  "2) EMH doesn't say it's impossible to beat the market, just really hard and very unlikely. In any case, at least certain segments of the financial industry spend lots of money on analysis, information gathering, proprietary modelling, trying to gain an "edge", etc. This would suggest either that they don't believe in EMH or that they believe they can be amongst the few that can beat the market."

  You don't have to "beat the market" to get a higher return. You can improve the market for all participants. You can do something that doubles the return of everything for everybody by getting rid of inefficiencies. But you still won't beat the market that way.

  Published: November 19, 2009 2:13 PM

• Shay

  fundamentalist, evolution doesn't mean moving towards a particular ideal life form, up a ladder; it simply means becoming more suited to the environment one lives in. Even million-year-old bacteria today are still evolving, and are very well-suited for their environment. They are not primitive or less-evolved than humans, merely state-of-the-art life forms for their habitat, as we are for ours.

  As the human environment changes, for example governments eliminating opportunities for self-discipline and prudent behavior, evolution will favor humans who lack self-discipline and are imprudent, because being otherwise would be a waste of energy and make one less-fit.
  

  Published: November 19, 2009 2:16 PM

• Fed Up

  Fundamentalist,

  "but we will eventually be grotesque monsters."

  Don't we already have those at the white-house ?

  I am not a christian and do not believe in creationism however I must admit to a certain intelligent "design" or process in biology.

  I do believe in evolution as a long term process and that we are descendants of early sea creatures like astraspis.

  But I find it extremely discouraging that we don't observe the effects of evolution in real time and that we can't do anything about it.

  If we would gain 100,000,000 neurons per generation, now that would be encouraging.

  But when I see what our consumerism and collectivist culture has done to us, I cannot accept that we are headed towards embetterment.

  Published: November 19, 2009 2:17 PM

• Fed Up

  Shay,

  "They are not primitive or less-evolved than humans,"

  I bet that Deinococcus Radiodurans would do a better job running our country than Barack Obama.

  Published: November 19, 2009 2:19 PM

• Fed Up

  Shay,

  "evolution will favor humans who lack self-discipline and are imprudent, because being otherwise would be a waste of energy and make one less-fit."

  Inflation already punishes those who work hard and save so I might as well burn my stash and indebt myself.

  Wouldn't such a critical mass of slobs weigh in on the government and drag it down with them ?

  When there will no longer be enough hard working and responsible individuals to prey upon, who will feed this mass of slobs ?

  Isn't that what's happening to the USA right now ?

  Our current political and economic system which favors such individuals is artifical and cannot stand the test of time. When reality finally reaches us, we will be in for a major catastrophe.

  Even if man invented socialism and freeloading, reality and the laws of physics haven't changed.

  I therefore predict a major humanitarian crisis and a major war coming up.

  Published: November 19, 2009 2:25 PM

• Walt D.

  fundamentalist said:
  
  "The really nice thing about the theory of evolution is that it predicts everything and its opposite. It's totally unfalsifiable."
  
  All the Theory of Evolution says is that the composition of the gene pool of a population changes over time. This is obvious for most organisms. However, to falsify this hypothesis we would have to take, say, a population of sharks, and monitor for changes over time. This could take millions of years!
  
  Falsifiability for science is a double edged sword. Originally, Popper was interested in why Einstein's Theory of Relativity was considered science whereas Marx's Theory of History was not. Popper came up with the idea of falsifiability because he could not see how to set up an experiment that would disprove Marx. (He did not consider the total collapse of the USSR as a possibility). Now, we have mainstream scientific theories such as String Theory that do not meet the criterion of falsifiability.

  Published: November 19, 2009 3:28 PM

• Ohhh Henry

  "We correctly predicted that we would not be able to predict it. The most important part of the much-maligned efficient-markets hypothesis (EMH) is that nobody can systematically beat the stock market. Which implies nobody can predict a market crash, because if you could, then you would obviously beat the market."

  If any adviser to Queen Elizabeth I gave a smart-alecky reply like that he would have had his head cut off and placed on a pike on London Bridge.

  These EMH ramblings seem to me like what a scientist would come up with while studying the behavior of pinball machines if he was ignorant of the laws of gravity, momentum, etc.

  The EMH economists, ignoring the basic principles of human action as applicable to economics - money, interest, prices, etc. - can only marvel at the lights and noise of the market and try to come up with some kind of "big picture" description of the machines which may help them identify certain recurring patterns of lights and bells but at any given time remaining ignorant of where the ball will go next.

  Published: November 19, 2009 4:04 PM

• fanofrothbard

  How to Argue Like a "Hardcore Austro Libertarian Mises-Rothbard Pure AnarchoCapitalist Hoppean":

  1. Assume everybody else is stupid....

  Published: November 19, 2009 4:27 PM

• Sonic Ninja Kitty

  "...the truth is we really are devolving. The human genome is deteriorating at about 1% per generation. We won't eventually be slugs, but we will eventually be grotesque monsters."

  Well, dang, this explains a lot! Those goofs in DC really ARE the most evolved among us!

  Published: November 19, 2009 4:32 PM

• fundamentalist

  Walt D. "However, to falsify this hypothesis we would have to take, say, a population of sharks, and monitor for changes over time."

  It depends on the level of evolution you want to test. Evolution occurs on two levels, 1) within families of animals and 2) between families of animals. #1 is easy to demonstrate; ranchers/farmers do it all the time, only they call it natural selection. It's not too time consuming to come up with new species of wheat, fore example.

  #2 is much more difficult. The fossil record provides a record of #2 evolution for long periods of time and the evidence for it is almost non-existent. If you don't believe me, check out Roger Lewin's book "Bones of Contention". Don't worry, he is an evolutionist, just an honest one. He won't try to convert you.

  Published: November 19, 2009 4:52 PM

• Bob Murphy

  Two points to defend my honor:

  (1) For those talking about the EMH and how it's consistent with a bubble, etc.: I am responding to popular defenses of the EMH, that are all variations of "you can't consistently beat the market." So I'm saying Thornton et al. showed us how to beat the market, if we just listened. You're right, EMH is consistent with the existence of a bubble, but then the claim is, "No one can know we're in a bubble till it pops." So I'm arguing in the article that that's been falsified. Thornton et al. called the bubble. You say, "He got lucky." OK what would have to happen? How else can someone disprove the EMH, than by calling a huge bubble before it pops?

  (2) Regarding Dawkins: Here is what he said. Nothing about the God of Abraham in here:

  Where does [Darwinian evolution] leave God? The kindest thing to say is that it leaves him with nothing to do, and no achievements that might attract our praise, our worship or our fear. Evolution is God’s redundancy notice, his pink slip. But we have to go further. A complex creative intelligence with nothing to do is not just redundant. A divine designer is all but ruled out by the consideration that he must be at least as complex as the entities he was wheeled out to explain. God is not dead. He was never alive in the first place.

  I said Dawkins claimed that evolutionary theory "by itself virtually disproves the existence of God." Looking again at his quote above, I am perfectly comfortable with my summary. That is just what he said.

  Published: November 19, 2009 6:10 PM

• GilesS

  "You're right, EMH is consistent with the existence of a bubble, but then the claim is, "No one can know we're in a bubble till it pops." So I'm arguing in the article that that's been falsified. Thornton et al. called the bubble. You say, "He got lucky." OK what would have to happen? How else can someone disprove the EMH, than by calling a huge bubble before it pops?"

  Presumably if somebody were to run a regression and estimated that next year unemployment would be x% and unemployment turned out to exactly x% he could say what you're saying to the Austrian who demurred, claiming that quantative prediction is impossible.

  Published: November 19, 2009 6:30 PM

• Abhilash Nambiar

  Dear Mr. Murphy,

  I think you have done a splendid job defending your honor. And you did use the word 'falsified' in your comment, which I found interesting.

  Would you care to comment on comment on the paper 'In Defense of Extreme Rationalism' by Hans Herman Hoppe?

  http://mises.org/journals/rae/pdf/rae3_1_16.pdf

  He seemed imply that a new better theory that the concept of falsification is flawed. A new theory (be it in economics or biology or any other field) that can better help us understand the world we live in does not 'falsify' an older theory, nor does it undo the successful applications of the older theory in the past. It only outcompetes it.

  Published: November 19, 2009 6:39 PM

• Abhilash Nambiar

  Dear Mr. Murphy,

  I think you have done a splendid job defending your honor. And you did use the word 'falsified' in your comment, which I found interesting.

  Would you care to comment on comment on the paper 'In Defense of Extreme Rationalism' by Hans Herman Hoppe?

  http://mises.org/journals/rae/pdf/rae3_1_16.pdf

  He seemed imply that a new better theory that the concept of falsification is flawed. A new theory (be it in economics or biology or any other field) that can better help us understand the world we live in does not 'falsify' an older theory, nor does it undo the successful applications of the older theory in the past. It only outcompetes it.

  Published: November 19, 2009 6:40 PM

• Abhilash Nambiar

  Dear Mr. Murphy,

  I think you have done a splendid job defending your honor. And you did use the word 'falsified' in your comment, which I found interesting.

  Would you care to comment on comment on the paper 'In Defense of Extreme Rationalism' by Hans Herman Hoppe?

  http://mises.org/journals/rae/pdf/rae3_1_16.pdf

  He seemed imply that the concept of falsification is flawed. A new theory (be it in economics or biology or any other field) that can better help us understand the world we live in does not 'falsify' an older theory, nor does it undo the successful applications of the older theory in the past. It only outcompetes it.

  Published: November 19, 2009 6:41 PM

• Mike D.

  Bob Murphy
  
  I also do not believe EMH. However, just to play devil's advocate, I need to bring up Warren Buffett's story about the 32 egotistical orangutans. On the 31st December each year, they flip a coin - heads the Dow Jones goes up, tails the Dow Jones goes down. They do this for 5 years. At the end of the 5th year one of the orangutans has a perfect track record of calling the market. Does this mean the market is not efficient? I think the key thing is that you have to be right for the right reason. It is still difficult to make money out of the current stock market bubble - we don't know how far it will go or when it will burst. Don't underestimate the value of Bernanke put options. However, as the baby boomers retire and pension fund managers have to liquidate stocks to fund retirees, (this is exacerbated by artificially low interest rates), a stock market crash becomes inevitable.

  Published: November 19, 2009 7:04 PM

• Sukrit

  Here's another "hilarious"">http://www.theaustralian.com.au/news/opinion/doomsayer-does-his-dough/story-e6frg6zo-1225799013391">"hilarious" defence of the EMH by Stephen Kirchner, fellow at a free-market think tank in Australia that favours central banking.
  

  Published: November 19, 2009 7:22 PM

• newson

  david janello says:
  "If the EMH were false, why did very few options market makers go bankrupt last year? Or after the dot-com bust? Or in the 1987 crash?"

  most of the heavy option-writers just happen to be banks! the banks cannot be allowed to fail. that would cause pregnant women to miscarry, and milk to curdle.

  Published: November 19, 2009 7:42 PM

• Mr Eko

  Bob Murphy,

  You knew exactly what you were doing with the Dawkins reference, and exactly what the militant athiests reactions would be.

  They never disappoint.

  Published: November 19, 2009 7:54 PM

• Ned Netterville

  When the businessmen finally learned that the boom created by credit expansion cannot last and must necessarily lead to a slump, they realized that it was important for them to know in time the date of the break. They turned to economists for advice.

  The economist knows that such a boom must result in a depression. But he does not and cannot know when the crisis will appear. This depends on the special conditions of each case. Many political events can influence the outcome. There are no rules according to which [p. 871] the duration of the boom or of the following depression can be computed. And even if such rules were available, they would be of no use to businessmen. What the individual businessman needs in order to avoid losses is knowledge about the date of the turning point at a time when other businessmen still believe that the crash is farther away than is really the case. Then his superior knowledge will give him the opportunity to arrange his own operations in such a way as to come out unharmed. But if the end of the boom could be calculated according to a formula, all businessmen would learn the date at the same time. Their endeavors to adjust their conduct of affairs to this information would immediately result in the appearance of all the phenomena of the depression. It would be too late for any of them to avoid being victimized.

  If it were possible to calculate the future state of the market, the future would not be uncertain. There would be neither entrepreneurial loss nor profit. What people expect from the economists is beyond the power of any mortal man.

  The very idea that the future is predictable, that some formulas could be substituted for the specific understanding which is the essence of entrepreneurial activity, and that familiarity with these formulas could make it possible for anybody to take over the conduct of business is, of course, an outgrowth of the whole complex of fallacies and misconceptions which are at the bottom of present-day anticapitalistic policies. There is in the whole body of what is called the Marxian philosophy not the slightest reference to the fact that the main task of action is to provide for the events of an uncertain future. The fact that the term speculator is today used only with an opprobrious connotation clearly shows that our contemporaries do not even suspect in what the fundamental problem of action consists.
  http://mises.org/humanaction/chap38sec3.asp
  

  Published: November 19, 2009 8:14 PM

• Ned Netterville

  Here is what Dr. Murphy wrote, which will hopefully save me from having to read Dawkins' book, for the words are attributed to the him.

  "Where does [Darwinian evolution] leave God? The kindest thing to say is that it leaves him with nothing to do, and no achievements that might attract our praise, our worship or our fear. Evolution is God’s redundancy notice, his pink slip. But we have to go further. A complex creative intelligence with nothing to do is not just redundant. A divine designer is all but ruled out by the consideration that he must be at least as complex as the entities he was wheeled out to explain. God is not dead. He was never alive in the first place."

  Hmmm. Dawkins, are you out there? Is that really what you said as a refutation of God? The God of my understanding designed evolution and evolving species. Furthermore, He (or She. or Both) is so creatively complex as to defy even rudimentary comprehension by merely human intelligence, not even the advanced logic of atheists. Humans trying to define God or trying to define him out of existence are engaged in the art of babble, or babel.

  Published: November 19, 2009 8:42 PM

• Nate Y

  I see no militant atheists on here. So there are those who believe that evolution pretty much destroys the idea of a creator. So what? I am among them. It appears the posters here want no coercion to be present and are content to leave the question up to the free market of ideas.

  Published: November 19, 2009 8:50 PM

• Walt D.

  It appears that Dawkins views God as a "Deus ex Machina"!

  Published: November 19, 2009 9:27 PM

• fundamentalist

  Mike D: “I think the key thing is that you have to be right for the right reason.”

  Good points. Some people are just lucky. However, the Austrian business cycle theory, especially the one developed by Hayek, is very good at explaining and predicting major turning points.

  Ned: “What the individual businessman needs in order to avoid losses is knowledge about the date of the turning point at a time when other businessmen still believe that the crash is farther away than is really the case.”

  Good points and I think Hayek’s business cycle does just that. The turning point comes when nominal profits are at their peak. Profits are high because price inflation is high and price inflation is high because monetary pumping by the Feds have pitted capital goods producers against consumer goods producers competing for scarce resources. In the recent cycle, profits peaked in the summer of 2007. They were the main news every evening. Mainstream economists were again crowing that they had eliminated business cycles. Of course, they had claimed the same thing just before the last three busts. The stock market continued to climb until October 2007, then began its long decline.

  Too many people insist on the false dichotomy that you must either forecast perfectly, or not at all. However, as Hayek said it’s better to be approximately right than exactly wrong. Hayek’s cycle cannot tell you the exact hour on which the economy and stock market will turn. But it can get you within the year, and probably within six months. That’s good enough to rescue your funds from the stock market.

  The Feds will likely keep rates low for another two years. With long lags between policy change and its effects, the stock market will probably keep climbing another two years after that. So we can look forward to about four years of a climbing stock market because the stock market is driven primarily by monetary policy, not the state of the economy.
  

  Published: November 19, 2009 10:54 PM

• newson

  to fundamentalist:
  you're probably right on the monetary stance of the fed, but the period 1968-1982 casts doubt on whether the share market is likely to benefit, medium term.

  high consumer and producer price rises killed the s&p. the loss was as much as the great depression, adjusted for inflation.

  the fed will create a share boom, but probably in taiwan and vietnam, not at home.

  Published: November 20, 2009 12:04 AM

• matt

  "It's a bit like comparing a Euclidean proof to a closing argument by Johnny Cochrane."

  Zing!

  Published: November 20, 2009 12:56 AM

• Mushindo

  fundamentalist said:

  'The really nice thing about the theory of evolution is that it predicts everything and its opposite. It's totally unfalsifiable.'.

  No, it is falsifiable. JBS Haldane is on record as having declared that finding a fossil rabbit under the precambrian would be enough to refute it.

  Fundamentalist also said:

  'FedUp, I know you meant to be funny, but the truth is we really are devolving. The human genome is deteriorating at about 1% per generation. We won't eventually be slugs, but we will eventually be grotesque monsters.'.

  'grotesque monsters' is an aesthetic judgment devoid of objectivity. IN some peoples eyes, bats are grotesque monsters on account of their ugly faces. But their (evolved) spatial perception through sound waves is nothing short of exquisite.

  Besides, if humans are devolving, how come theres 7 billion of them alive now, as compared to less than a billion up to 200 years ago? By any biological standard of success ( viz survival and procreation), that makes humans one of the most successful organisms ever.

  Published: November 20, 2009 1:02 AM

• Walt D.

  One of the fallacies exposed by the genome project was that humans would have the most complex genome. Rice and wheat grass have much more complicated genomes. There is no "evolutionary ladder".
  
  To throw in another six eggs, The genetic role in behavior has not been determined. Many scientists (mea culpa,mea culpa from the global warming fallacy) believe (as opposed to know) that religion is coded in the genome. (So God in in everyones head - see the end of the film Stigmata). Dawkins believes that religion is coded into the genome and that it causes undesirable behavior such as aggression. This he believes could be treated by gene therapy to suppress this undesirable trait.

  Published: November 20, 2009 1:32 AM

• Fed Up

  Mushindo,

  How many ants and insects are they on this planet ?

  Answer: Trillions upon trillions !

  From your logic, insects are more successful than humans.

  Published: November 20, 2009 6:56 AM

• fundamentalist

  Mushindo: "JBS Haldane is on record as having declared that finding a fossil rabbit under the precambrian would be enough to refute it."

  No, it wouldn't be enough. Evolutionists would just explain it away. Scientists have discovered literally thousands of fossils that contradict evolution and evolutionary scientists merely invent an explanation for them or simply ignore them. Check out the book at creationscience.com for many examples. No amount of evidence will convince evolutionists that evolution is wrong if they don't want to know the truth.

  Mishindo: "if humans are devolving, how come theres 7 billion of them alive now, as compared to less than a billion up to 200 years ago?"

  Typical evolutionist. You ignore all contradictory evidence. The human genome has been accumulating harmful mutations for ever. Some of those are fatal, such as genetically caused cancer. Most are not fatal. The scientific fact about genes is that harmful mutations outnumber beneficial mutations a million to one. When death rates were much higher, most harmful mutations were eliminated. The deterioration rate has increased with the advent of modern medicine and capitalism, which ended famines in the West.

  As for the increase in population, that is due primarily to capitalism. As Hayek wrote, capital accumulation has enabled the planet to support a far higher population that it could have using pre-capitalist methods of production. Those extra six billion people would have starved to death before capitalism.

  Published: November 20, 2009 8:23 AM

• fundamentalist

  newson: "period 1968-1982 casts doubt on whether the share market is likely to benefit, medium term."

  I see that period as being slightly different from today because of the Vietnam war. The guv was spending most of the new money that the Feds created and that translated into cpi inflation and not asset inflation. Of course, the guv is spending a lot today to stimulate the economy, so that raises the likelihood of cpi increases. Since then, Fed pumping tends to increase asset values and lead to bubbles and not so much cpi increases.

  Published: November 20, 2009 8:27 AM

• david janello

  'most of the heavy option-writers just happen to be banks! the banks cannot be allowed to fail. that would cause pregnant women to miscarry, and milk to curdle.'

  Option-writing is not options market making.
  Many readers on this board would benefit from reading an intermediate-advanced options text, e.g. John Hull or Charles Cottle.

  Published: November 20, 2009 8:34 AM

• Mushindo

  Fed Up said:

  
  How many ants and insects are they on this planet ?

  Answer: Trillions upon trillions !

  From your logic, insects are more successful than humans.

  Response: Quite. May I take it even further? In terms of biomass, as observed by the late Steve Gould , on average all life is bacteria. And it s never been materially different - for at least the last 3.5 bn years.

  Published: November 20, 2009 9:31 AM

• Fed Up

  Mushindo,

  So humans have a very anthropocentric and narcissistic view of evolution.

  The mass of all ants is as much as the mass of all humans. And we're just talking about ants, not about the rest of insectdom.

  Published: November 20, 2009 10:39 AM

• Mark Davis

  I appreciate the "this is funny" take on the whole EMH debate which is as perfectly academic as it is completely void of relevance to real market participants. Basically: "Who cares?" Further, different markets have various degrees of efficiency. I would say that everything else being equal, the more efficient a market is at disseminating broad knowledge then the less likely a bubble is to occur and vice versa. But that’s like saying: unless there is a storm when the tide comes in the beach gets smaller, and vice versa. How useful is that?

  Yet even when everybody knows that the Fed is artificially lowering interest rates to “stimulate the economy” which leads to bubbles everywhere, the band wagon gets bigger and louder. Focusing on how efficient that is only makes sense to someone who doesn’t have any skin in the game and likes to look down from tower windows. “Gee, look at all those brilliant fellows climbing aboard; how efficient they are!”

  Ned gets close to it: “What the individual businessman needs in order to avoid losses is knowledge about the date of the turning point at a time when other businessmen still believe that the crash is farther away than is really the case.”

  Some of us sold our real estate and stock holdings at the peak of the market and stopped buying more because we believed they were ready to fall in price. Obviously others had to buy what we were selling because they thought that these assets were still increasing in value and were still a good deal. Even if everybody had the same knowledge within any particular market, we all assess the risks and opportunity costs very differently. Thus we can, nay must, each come to opposite conclusions as to what side of a trade to be on. Or there would be no market.

  If markets were really super efficient then there would be no trades to speak of. Basically, you don’t have to “beat the market” just the guy on the other side of your deal. This is also why it so often pays to be a contrarian. The rest is window dressing and entertainment.

  The references to religious beliefs are getting boring and I don’t see where they have a place here.

  Published: November 20, 2009 11:26 AM

• @Mushindo

  Animals are centrally planned bacteria.

  Published: November 20, 2009 1:00 PM

• newson

  to fundamentalist:
  i think that once money is created ex-nihilo, then a bubble or distortion is inevitable. we just cannot know precisely where the bubble is, nor its size, nor the timing of its evolution.

  i think that as much as the government would like the recent money-creation to return to financial assets, no bubble that has burst is ever revived in exactly the same sector as before. given the low price of commodities in real terms, and the very low gearing of the sector, plus appealing fundamentals, and given also the rich valuation (still) of financial assets in general, i'm still more convinced that this coming period will be a far nastier version of the 1970's. where financial assets did poorly, and commodities did well.

  vietnam yesterday, today iraq and afghanistan.

  Published: November 20, 2009 9:09 PM

• newson

  to david janello:
  yes, i am aware of the difference. i cop a demerit point for poor comprehension.

  that the emh excludes risk-free arbitrage - this seems illogical. surely the very act of arbitrage is itself a proof that risk-free profits are possible, even if they are evanescent. that these profits disappear as they are acted upon doesn't make them less real.

  Published: November 20, 2009 9:29 PM

• newson

  what are the odds of warren buffett's risk-adjusted returns after many decades being merely attributable to luck?

  i thought the emh denied the possibility of systematic, individual outperformance (on a risk/return adjusted basis), and not just that it was unlikely.

  Published: November 20, 2009 11:28 PM

• fundamentalist

  Newson, you could be right. Do you know what investments performed well in that period, if any? I know oil did well, what about other commodities? Real estate?

  Published: November 21, 2009 8:07 AM

• Brian Macker

  Bob Murphy,

  You should refrain from speaking on the topic of biology and Dawkin's until you become educated on the subjects. This reminds one of the ridiculous creationist posts you used to put on Lew's site.

  The god Dawkin's is describing subsumes the god of Abraham. It just doesn't subsume the god of Spinosa. So it wasn't an attempt to disprove god in the generic ambiguous sense.

  It's quite easy to both logically disprove and empirically falsify certain conceptions of god. Dawkin's has done so.

  You are certainly open to redefining what the god of Abraham is so as to attempt to refute Dawkin's point but he uses a particular definition so doing so would be equivocation.

  Here, let me give it a shot. The god of Abraham is a mythical being. Therefore Dawkin's argument is wrong because one cannot disprove the existence of myths this way. No more than he could disprove the existence of the myth of Santa Claus. Santa certainly exists as a mythical being.

  Of course, Dawkin's would laugh at this, just as he would laugh at your ridiculous argument.

  Let's stick to economics lest the site get bogged down in religion and pseudoscience.

  Published: November 21, 2009 9:41 AM

• K Ackermann

  Ants thrive beautifully, and their contribution to the rise in entropy is minimal.

  As a species withing the biosphere, they are off the charts more successful than humans.

  Published: November 21, 2009 12:45 PM

• newson

  to fundamentalist:
  yeah, real estate had a boom in 1973-74, as did all the commodities. but those were the days before the democratization of credit, so the property bubble was infinitely smaller than today. to me, only agricultural property has the winning combination of low debt, and likelihood of rising earnings.

  thirty-three years of pain - downtrend in real prices - for the foods, until 2007. in 1972 the breakout from the previous trading range ushered in very much higher prices. i am expecting similar behaviour in the next years.

  http://www.futuresbuzz.com/wheatlt.html

  Published: November 21, 2009 11:04 PM

• ?

  "thirty-three years of pain - downtrend in real prices - for the foods"

  So if food just fell from the sky, that would be "painful"?

  Published: November 21, 2009 11:08 PM

• newson

  yes, congress would face an angry farming sector, and would pass the anti-manna bill.

  Published: November 21, 2009 11:28 PM

• ?

  You should block out the sun then. The sun decreases food prices.

  Published: November 21, 2009 11:31 PM

• ?

  And block CO2 as well. Because CO2 is plant food, which means more of it gives you more plants, which reduces food prices.

  Oh, wait...

  Published: November 21, 2009 11:33 PM

• ?

  "in 1972 the breakout from the previous trading range ushered in very much higher prices. i am expecting similar behaviour in the next years."

  Cap n Scam = less plant food = less food = higher prices
  Cap n Scam = higher energy costs = harder to grow food = less food = higher prices
  Ethanol = less food = higher prices
  Subsidies = paying farmers to destroy and/or not grow food = less food = higher prices
  Printing Presses = hyperinflation = even more worthless money = higher prices
  Genetically Modified Food Patents = government-backed monopolies = higher prices
  Tariffs = higher prices
  Quotas = higher prices
  Food Stamps = higher prices

  Cap n Scam (x2) + Ethanol + Subsidies + Printing presses + Genetically Modified Food Patents + Tariffs + Quotas + Food Stamps = riots

  Published: November 21, 2009 11:45 PM

• david janello

  Now we are getting somewhere.

  Two intelligent questions.

  >>that the emh excludes risk-free arbitrage - this seems illogical. surely the very act of arbitrage is itself a proof that risk-free profits are possible, even if they are evanescent. that these profits disappear as they are acted upon doesn't make them less real.

  In the real world pure arbitrage opportunities are few and far between.

  The EMH lets options market makers capture profits even when arbitrage opportunities do not exist. And in a volatile, unlimited risk market. How is this possible? The market makers charge a bid-ask spread. The EMH models neutralize (imperfectly) the risk long enough for the market maker to set up a 'lock' or risk-free position. Note that if a retail investor or hedge fund uses the exact same strategy he or she will lock in the loss of the bid/ask spread. The game for market takers is very different from the game for market makers.

  See the Charles Cottle book for a good description of this.

  When options market makers make mistakes calibrating their models they go bust and the clearing firm liquidates their account. This happens on a daily basis. Bad market makers are driven out by good market makers.

  >>what are the odds of warren buffett's risk-adjusted returns after many decades being merely attributable to luck?

  Buffett's returns are based on 100% risk of invested capital (for his stock positions) and > 100% risk of invested capital for his insurance and re-insurance positions. So even if the mathematical odds were 0% that Buffett achieved his results by luck the EMH still holds.

  A common misconception about the EMH is that it says that outperformance is impossible/unlikely etc. The EMH in all of its forms refers to risk-free outperformance. So if you tried to use Buffett-style investing in a risk-neutral world, like options market making, you would go bust. In a risk-seeking world, like long-term value investing or short-term speculative trading, the EMH is much more ambiguous.

  Published: November 23, 2009 9:32 AM

• newson

  to david janello:
  yes, pure arbitrage opportunities are rare, but that's precisely because someone has exploited the mispricing and profited. different people get the profit, of course.

  i thought the emh posited that outperformance could only be associated with higher risk. that is, a fund manager could not deliver higher returns without a correspondingly higher variance, over a reasonable time. so buffett's performance would be anomalous.

  Published: November 24, 2009 5:51 PM

• david janello

  newson wrote:

  "i thought the emh posited that outperformance could only be associated with higher risk..."

  The critical ambiguity here is the definition of "higher risk" which is arbitrary and in most real-life cases meaningless. Many textbooks use variance as a risk measure which works well most of the time, until it doesn't. Fannie and Freddie were low variance stocks for many years. Fannie and Freddie were also low risk investments based on fundamental Graham and Dodd type analysis, which is why they were recommended by noted value managers such as David Dreman and purchased by the mutual funds he managed.

  Unlike many 'value' investors, market makers in Fannie and Freddie options survived the turmoil. Over the years market makers added critical refinements to the EMH that take into account assymetrical risks. For example, the out-of-the-money puts in many options trade for higher prices than out-of-the-money calls, which should not happen in a pure EMH model like black scholes or the binomial model. These nuances allowed the market makers to adjust their positions and make two-sided markets during the onslaught.

  Published: November 30, 2009 9:23 PM

• newson

  to david janello:
  when i had to study emh, variance was indeed used. but what you're saying is that emh is not even able to be defined in a black-and-white fashion.

  Published: December 1, 2009 3:37 AM

• david janello

  >>to david janello:
  >>when i had to study emh, variance was indeed used. but what you're saying is that emh is not even able to be defined in a black-and-white fashion.

  In the real world every trader needs to define his or her own black-and-white definition of the EMH and test it out with real money. So there are a lot of opinions on the best way to do EMH. Over time the best traders become successful traders and the not-so-good traders become former traders.

  The things they teach in grad school are interesting in theory, but as Charles Cottle points out in his book Options : Perception and Deception,

  'The difference between theory and practice is the difference between profit and loss.'

  Published: December 2, 2009 12:39 AM

• newson

  to david janello:

  but it's either a specific theory or it's not. whether it has practical merit is another question.

  Published: December 2, 2009 1:12 AM