There are two ideas in economics that have bothered me for a long time. The first, attributable to Adam Smith, is that an invisible hand
guides capitalist markets to a socially optimal solution. The second is that markets, particularly the United States stock market, fully integrate all available information into the price of a security, which is the economically optimal price for that security. The latter, called the efficient market hypothesis, has dominated capitalist thinking in the U.S. for quite some time.
There are two underpinnings of capitalist economics. Scarcity and rationality. Goods are scarce, meaning we can’t use as much as we want of everything, whether it be time, money, air, food, entertainment, etc. We always have to make choices. The second is that people make their choices rationally; they act in their own best financial interest given all the information needed. I have no problem with scarcity. Rationality flies in the face of everything I’ve seen about people. And rationality is the underpinning of the two economic ideas above.
Adam Smith’s quote is actually referencing a pretty narrow piece of economics, not the broad Ayn Rand style statement about markets that so-called conservatives make it out to be. The classic refutation of that is the prisoner’s dilemma. Two actors in that case will, if they seek to maximize their own situation, cause the non-socially optimal solution to occur. But that’s hardly a general refutation. And in fact, I personally am convinced that the invisible hand is a good rule of thumb.
The efficient markets hypothesis in it’s rule of thumb format seems to me to be a good rule of thumb. Generally speaking, an individual cannot beat the market except through luck. But in it’s most strident form of taking into account all information, even non-public information, I call utter bullshit. But until now I didn’t have the background to say so.
The Myth of the Rational Market is an extensive history of the efficient market hypothesis, starting in the late 1800s and continuing all the way through 2008. It covers all the major players, explains the discoveries and theories that lead to the hypothesis, and explains how it came unraveled in the 1980s and beyond. As economics can be, sometimes it was a little hard to keep all the threads aligned in my head. Fox does a fairly admirable job of juggling them all, better than many economics texts I’ve read.
It’s rare for me to finish an economics book and feel better informed with information on issues that I actually discuss with friends. Okay, mostly I’m talking about wing-nut friends who like to post the market is always best
tripe on Facebook or LiveJournal. Now I’ve got the evidence to say you’re an idiot
.
And despite the book being flogged by a few people as about the financial market meltdown the last few years, it’s only tangentially related. It doesn’t hurt understanding of that crisis, but only the epilogue touches directly.
A few other blogged reviews:
Title: The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street
Author: Justin Fox
Imprint / publisher: HarperBusiness / HarperCollins
Format: Hardcover
Length: 382 p. (includes notes and index)
Publication date: 2009
ISBN-13: 978-0-06-059899-0
