In a recent post I pointed to a weird asymmetry. Even though bubble theory proponents think that prices are more likely to fall after a large run-up, those who correctly predict that prices will go even higher seem less famous (at least in America) than those who correctly predict the bubble will burst (which is allegedly the easier market call.) I suggested this is just a part of the general problem of cognitive bias, which leads people to see patterns where there is actually nothing more than randomness.
In the comment section of a recent Tyler Cowen post, Rajiv Sethi made the following observation:
Let me repeat that I admire Scott Sumner, the coherence of his vision, and his general approach to blogging (as laid out in his amazing birthday post). But I think that his faith in market efficiency is misplaced and his glib dismissal of those who take bubbles and crashes seriously (we suffer cognitive illusions) baffling.
On a certain level I agree with Sethi (who is a very smart guy.) There’s nothing people like less than for someone to respond to their argument by calling them irrational, or suggesting they have bad motives. But this also raises an interesting problem for the bubble theorists. Unless I’m mistaken, most anti-bubble theories assume some sort of irrationality among market traders, or dare I say, cognitive illusions. (Which is supposedly “proven” by economic experiments which in fact do nothing of the sort.) I’m not sure Sethi was actually complaining about my cognitive illusions comment, although I got that impression. But if so, is it really any different from what the bubble theorists assume about asset market participants?
I need to constantly repeat a very important point; I’m not arguing the EMH is true. I’m arguing the EMH is useful and that anti-EMH models are not useful. The reason I don’t think the EMH is true is because I believe market participants do have cognitive illusions. And the reason I don’t think the anti-EMH theory is useful is because I think academics and policymakers are equally susceptible to cognitive illusions.
Paul Einzig made the same basic argument back in 1937:
“On June 9, 1937, this veteran monetary expert [Cassel] published a blood-curdling article in the Daily Mail painting in the darkest colours the situation caused by the superabundance of gold and suggesting a cut in the price of gold to half-way between its present price and its old price as the only possible remedy. He took President Roosevelt sharply to task for having failed to foresee in January 1934 that the devaluation of the dollar by 41 per cent would lead to such a superabundance of gold. If, however, we look at Professor Cassel’s earlier writings, we find that he himself failed to foresee such developments, even at much later dates. We read in the July 1936 issue of the Quarterly Review of the Skandinaviska Kreditaktiebolaget the following remarks by Professor Cassel: ‘There seems to be a general idea that the recent rise in the output of gold has been on such a scale that we are now on the way towards a period of immense abundance of gold. This view can scarcely be correct.’ . . . Thus the learned Professor expected a mere politician to foresee something in January 1934 which he himself was incapable of foreseeing two and a half years later. In fact, it is doubtful whether he would have been capable of foreseeing it at all but for the advent of the gold scare, which, rightly or wrongly, made him see things he had not seen before. It was not the discovery of any new facts, nor even the weight of new scientific argument that converted him and his fellow-economists. It was the subconscious influence of the panic among gold hoarders, speculators, and other sub-men that suddenly opened the eyes of these supermen. This fact must have contributed in no slight degree towards lowering the prestige of economists and of economic science in the eyes of the lay public.” (1937, pp. 26-27.)
Sub-men and supermen. Hmmm . . . I wonder into which group Paul Krugman would place himself?
Now let’s see if we can draw a broader set of conclusions from this pattern, these asymmetries. We’ve seen bubble predictors are treated differently from bubble deniers, and in the previous post we saw that conservatives were gung ho about focusing on commodity prices, except when commodity prices showed a desperate need for much easier money. Can we find a third example?
How often have you heard people remark that high gasoline prices are caused by the machinations of oil market speculators? But we know that the net demand for oil by speculators averages out to roughly zero in the long run. This means that for every period where speculators are raising prices, there is another period where they are reducing prices. But how often in general conversation do you hear people say:
Hmmm, gas is really cheap right now, I wonder if speculators are depressing the price?
Because I’m a mind reader, I can answer the question for you. Zero times. And it’s not just because people prefer to talk about bad news, they don’t even think speculators depress oil prices.
The world is full of this sort of asymmetrical thinking. And it’s almost always a sign of sloppy thinking, of cognitive illusions. And it often leads to bad public policy.
PS. This isn’t an exact analogy, but notice that narcotics and sex transactions are usually considered bad if money is involved. But in most societies the selling of sex and drugs is considered far worse than the buying of sex and drugs, even though each participant has an equal role in the transaction. A sign of bad public policy?
PPS: Five minutes after posting this I came across another example. We think that people who make lots of money are evil villians, whereas people who lose lots of money are innocent victims. Consider the following:
Earlier that year, Picard claimed in court filings that Picower was a key beneficiary of Madoff’s scheme. The trustee said Picower had withdrawn $7.8 billion from Madoff’s firm since the 1970s, even though he only deposited $619 million. Picower “knew or should have known that [he] was profiting from fraud, because of the highly implausible high rates of return” on his accounts, the trustee said.
Right after the Madoff scandal broke all the brain-dead critics of laissez-faire said “see, this shows that unregulated capitalism doesn’t work.” Eventually people pointed out that we don’t have unregulated capitalism, the SEC is supposed to prevent these sorts of abuses. Even worse, someone told the SEC about the Madoff fraud, and even pointed to absurdly high and persistent rates of return that anyone with half a brain knew were impossible. Or anyone who believes in the EMH knew were impossible. But apparently the SEC is one of those groups that doesn’t find the EMH to be “useful.” So they ignored the whistle-blower. Now when we find someone who actually made off with lots of money from Madoff (pun intended) we react in horror. Surely that rich bastard knew he couldn’t be earning that money legitimately!
That’s right, the supposedly expert SEC is given a pass in not responding to these high returns, as people keep insisting this shows we need still more regulation. But the person that benefited, who like all humans would just love to think his success was well earned, that it resulted from his investment acumen, is somehow obviously guilty.
I give up.