Economics for the Intelligent Amateur

In the wake of the recent controversy surrounding Free Markets, and more specifically, the “How could we be so stupid as to believe markets could work?” statements, we feel it is time to clear the air and make a couple blanket statements:

Efficient Markets does Not mean continuous growth
It is excusable in a way. We equate efficiency with working well, and we assume that an economy which works well will continue to rise. On the other hand, for an economy to work well it will have to get rid of the dead weight companies every now and again. Schumpeter famously called this “Creative destruction” and we (not as famously) declared that once the dust settled, our economy should be better off thanks to this downturn. Lehman Brothers, Bear Sterns, AIG and the like were riddled with bad management, overly risky investment, unrealistic expectations and outright fraud. Are these companies that deserve to continue operating? And what does it take for them to stop? A financial crisis, that’s what.

Free Markets does not mean “at no cost”
Although we sort of assumed this was obvious, we have seen some misconception in this regard (this might be our fault for following AlterNet.org on Twitter). Free Markets means Free of intervention, so that market forces can operate without obstruction. It does not mean Free as in the “Buy one get one free” variety. There are obviously costs for participating in the market. If markets are efficient, the costs are entailed and understood. Every time a stock rises, someone buys and someone else sells, then when the stock falls, someone sells and someone buys. By definition, someone will have gained and someone will have lost. On the other hand, these are the risks entailed. The interesting thing is that outside of the stockmarket, there can be many participants, all of whom are winners.

No, Virgina, stocks won’t always rise
This brings us to the final point. While the first two points were more a question of semantics, this is an outright fallacy. If you had bought into the S&P 500 at the beginning of 1999, right now you would have an 8% loss, and this is not counting for inflation. You can argue that we are in a downturn. On the other hand, between this recession, the dot com bubble, the 1987 crisis, etc. we can see these downturns are more commonplace than we might have thought.
A stockmarket should, in theory, reflect the economy as a whole, which is where this fallacy arises. On the other hand, the S&P 500 (generally agreed to have the broadest scope), lost more in the 00’s than in the 1930’s, while the economy grew at around double the rate. As more online companies and small business start gaining credence and traction, the top 500 companies of the country will be having less and less influence. Expect it.

We have all heard of Joseph Stiglitz; the Nobel prize winning economist who releases books every now and then. You may also be familiar with his belief in more regulation for the economy and his criticism of President Obama’s rescue plan for the financial industry, famously remarking that whoever came up with it is “either in the pocket of the banks or they’re incompetent.”

It should also come as no surprise that Stiglitz holds globalization in contempt, especially given the title of his most famous book: “Globalization and its discontents”. While he argues some of the same points in his newest book “Freefall”, neither of these interest us at the moment. We are more interested in his advocacy of “Financial Circuit Breakers”. In a recent paper, he writes that full separation of markets is preferable to full integration.

To be fair, he deals with extremes (either complete separation or complete integration), but we find such a statement rather short sighted nonetheless. Apart from the fact that it flies into the face of 200 years of economics and around 4,000 years of history, his analogy with circuit breakers seems very worrisome. Circuit breakers are operated by a central location that decides when and where to allow the flow. Financial markets comprise of millions of participants. We have seen how disruption of the flow of electricity in just one location can have disastrous consequences (the blackouts in recent years in California and New York), as well as in other industries (oil production in the Middle East and gas production flowing from Russia). Is this really our solution for Financial Markets?

Full paper available here.

No, not of the Groceries variety, but of the mask and cape variety. More specifically: beating evil dictators at their own game.

Those of you who read The Economist or follow our Tweets (conveniently accessible here: @Dumbagent) may have seen how Kim Jong-il was finally forced into an apology thanks to economics.

It seems that the Dear Leader, as part of a crackdown on private enterprise (all the big corporates of North Korea?) decided to drastically re-denominate the North Korean Won. This caused the currency to collapse, and the price of rice rose around 50 times. This policy, therefore, had to be undone, which it promptly was. The surprising part, however, is that Kim Jong-il then apologized to the North Korean people.

For a man who boasts that birds and crops follow his command, and that golf is too easy for him (He scored 38 under par on his first try), an admittance of being mistaken and an apology directly to the Korean people is huge. Of course, they are still living extremely miserable lives that he doesn’t seem close to alleviating, but we still applaud the power of markets to bring him to his knees at least once.

Along the same vein of our last article on this subject, we continue to find amusing investment tips in Kiplinger’s:

Page 31 of their February 2010 edition is called:
Make a Buck off a Sagging Dollar – by Andrew Tanzer
This articles states how, since the US Dollar is falling, what alternatives an investor should find in order to make money.

Page 34 of this same edition has:
Don’t Write Off the Dollar Yet – by Jeff Kosnett
And you guessed it, Kosnett is saying that the Dollar is still going to ride strong. His blurb states: “The Dollar continues to account for 65% of the world’s currency reserves.”

Of course, the conclusion to draw here is that Kiplinger’s will provide different points of view, so for investors to look to them for investment advice will not provide definite answers. This is namely because there are no definite answers, just the same various theories recycled over and over. None of which is full proof. We can’t help wondering how much is really gained by reading this type of advice regularly.