Make sure you follow the right crowd
Over at Econlog, I have a post explaining why Brexit is not about Britain. That’s clearly not the conventional view, if you read the pundits. Philo asked this question:
Scott, you really do think for yourself, rather than just following the crowd–for example, the crowd of economists. (That means you are a genius or–somewhat more likely–a crank.) All the more surprising, then, that, in some of your epistemological posts, you advise *us*, your readers, to *follow the crowd*!
The best way for me to explain this issue is to point to those European stock markets that fell by 3 times as much as British stocks. The French and German markets were down around 7% or 8%, while the southern markets fell even more sharply. In contrast, the British market was only down 2.75%. This has been called the biggest day in British history since WWII, but it’s probably not that big a deal for the UK economy.
So yes, pay attention to the crowd, but make sure it’s the crowd who puts their money where their mouth is. That would be the asset markets, plus Bryan Caplan.
I’m also seeing a lot of confusion about the nature of uncertainty. Unlikely things happen every day; it’s no big deal. Every time the Dow moves more than 1% in a day, that’s an unlikely event. A couple weeks ago, Cleveland was down 3-1, and had about a 5% chance of winning it all. They did. So when something with a 25% chance occurs, it’s no big deal. One in every 4 elections sees an upset of that magnitude.
Let’s think about what the markets are telling us. In my view the 7% or 8% fall in European stocks should be viewed as a 20% chance of a catastrophic eurozone breakup as a result of Brexit (as compared to the previous probability) in which case markets might plunge 30%, and an 80% chance that this crisis will be papered over, as previous Greek crises were papered over, and markets recover. I think this confuses people, as the 7% or 8% fall is almost certain to be “wrong”, ex post. Either stocks should have fallen 30%, or almost not at all.
Those who see Brexit as a “real shock” that disrupts British trade are missing the big picture. (Here I agree with Krugman; changes in trade rules at the margin are not of much macroeconomic significance, although they are certainly unwelcome if protectionist.) The conventional pundits who focus on Britain have no explanation for the stock market figures I cited, and probably attribute it to “irrationality”, or “fear”. It much simpler than that—the eurozone is a dysfunction monetary regime, and the UK pound is not. (I suspect that’s why the Japanese market fell sharply—the BOJ is an increasingly dysfunctional institution, which has recently seemed to give up on its goal of 2% inflation.)
I know that we like certainty, but the truth is that we just don’t know what will happen. We don’t even know whether Britain will leave the EU. I think it will, but I’d guess there’s at least a 25% chance that Scotland won’t, and at least a 5% chance that the negotiations about how to do so will drag on for several years, by which times the voters will be asked once again. The young favored staying by a 3 to 1 margin, so time is on the side of those Brits who favor a cosmopolitan UK. Every day another Little Englander dies off, and another pro-EU Brit turns 18. Recall that in Europe, every time the voters of a country voted the “wrong way” on an EU referendum, they were asked to re-vote until they “got it right”. Again, I think Britain will leave, but nothing is certain in the world of politics (as I learned when I said Trump had no chance of getting the nomination.)
Here’s the wisest way to view market forecasts:
1. Market reactions will almost always later be shown to have been “wrong”. But which way?
2. Nonetheless, market forecasts are the best read we have on the implications of any shock, including Brexit.
PS. If you believe the claims I made in my earlier “You’re not special” post, then objectively speaking it’s more likely that I’m a crank than a genius. Keep that in mind, and read all my posts with a very skeptical eye.
PPS. Those who claim that Britain may have done the rest of the world a favor by providing a cautionary tale for a withdrawal from globalization better take another look at those stock markets. There are cautionary tales of illiberalism out there, like Venezuela, but don’t assume the UK will become one of them.