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August 14, 2007

Quote of the Day

Chris Dillow:

But these gyrations also invites every idiot to repeat the cliché, “it’s all about greed and fear”, as if this were anything other than vacuous. And abandoning the elegant discipline of conventional economics opens the door to every crank. To paraphrase G. K. Chesterton, when people stop believing in orthodox economics, they start believing not in nothing but in anything.

August 14, 2007 in Economics | Permalink


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“it’s all about greed and fear” = "it's about sentiment" = "markets are not perfectly rational" = "markets are not always efficient".

That's not vacuous. It's a simple observation that much of economic theory is pretty useless for predicting the markets (the very point that Chris makes in his piece).

Posted by: Kay Tie | Aug 14, 2007 10:21:00 AM

"It's a simple observation that much of economic theory is pretty useless for predicting the markets (the very point that Chris makes in his piece)."

Chris Dillow's piece is absolutely excellent but surely the mainstream textbook view of stockmarket prices has long been that the prices move like a "random walk with drift" - to quote from, for example, Brealey & Myers: Corporate Finance, which is very mainstream. That's why Efficient Market Hypothesis pundits - like Burton Malkiel, author of: A Random Walk Down Wall Street - say monkeys with dartboards will tend to do better on average than professional stock pickers, always excepting Warren Buffett, of course:

The random walk with drift view of stockmarkets explains why so many pension funds have tended to switch from actively managed portfolios, which need expensive stock pickers to manage them, to market tracking portfolios, which don't and which are guaranteed to perform at least as well as the overall market does. I think the really challenging focus of discussion is about how some active investors like Warren Buffett have been so successful. My understanding is that he invests for the long-term and selects stocks of companies which have, on his reckoning, a sustainable competitive edge in their product markets.

Posted by: Bob B | Aug 14, 2007 11:12:15 AM

"My understanding is that he invests for the long-term and selects stocks of companies which have, on his reckoning, a sustainable competitive edge in their product markets."

Which prompts one to ask what, precisely, everyone else is doing?

Posted by: Cleanthes | Aug 14, 2007 11:38:37 AM

As I learnt last week, he's not paraphrasing G.K.Chesterton at all. From wikiquote:

* When people stop believing in God, they don’t believe in nothing — they believe in anything.

* This quotation actually comes from page 211 of Emile Cammaerts' book The Laughing Prophets (1937) in which he quotes Chesterton as having Father Brown say (in "The Oracle of the Dog" from 1923): "It's the first effect of not believing in God that you lose your common sense." Cammaerts then interposes his own analysis between further quotes from Father Brown: "'It's drowning all your old rationalism and scepticism, it's coming in like a sea; and the name of it is superstition.' The first effect of not believing in God is to believe in anything: 'And a dog is an omen and a cat is a mystery.'" Note that the remark about believing in anything is outside quotes - it is from Cammaerts. The American Chesterton Society has explained the origin of the phrase.

Posted by: Matthew | Aug 14, 2007 12:01:34 PM

"Which prompts one to ask what, precisely, everyone else is doing?"

There are many strategies for playing stockmarkets - like selling stocks short which you expect to fall in price in the near future or there's what's colloquially known as "pump and dump":

"WHEN journalist James Hipwell was caught tipping shares he owned in his Daily Mirror City Slickers column, he ended up spending six weeks detained at Her Majesty's pleasure."

And then there's insider trading - which is unlawful but which apparently happens a lot, as instanced by the extent of tracked upward/downward movements in stock prices before the official release of market sensitive information.

Besides, the success of the Buffett way requires a pretty deep understanding of how product markets work in order to assess sustainable competitive edge - there's all that stuff from Michael Porter on: Competitive Strategy (Free Press 1980) and John Sutton on: Sunk costs and market structure (MIT press 1991):

Instead of going on about stock prices, stock pickers could dwell with greater relevance on what factors contribute to the competitive edge of companies.

Posted by: Bob B | Aug 14, 2007 12:29:12 PM

I predict that share prices will rise in the long term.

Posted by: johnnybonk | Aug 14, 2007 1:07:11 PM

"I predict that share prices will rise in the long term."

That's the drift bit. But not all companies survive over the long term - and we also come across challenging cases where world leading companies - like General Motors, for instance - lose their position of leadership to competitors - like Toyota - as well as, sadly, instances of massive corporate fraud like Enron and WorldCom.

In recent years in Britain, look what happened to Marconi:

"Marconi was once the jewel in the crown of British manufacturing. But disastrous investments have seen some of the worst losses in UK corporate history - over £5bn. The Money Programme investigates how a cautious company with billions in the bank set off on a rollercoaster ride to ruin.

"Marconi was once Britain's biggest and best known manufacturing concern. Until last year it was cheered by the City and its shares soared in value. Today Marconi has become notorious as one of the worst disasters of British corporate history."

Why do some countries have business environments more conducive to nuturing the formation and growth of big global companies than others?

Posted by: Bob B | Aug 14, 2007 1:59:32 PM

"I predict that share prices will rise in the long term."

As Marie Curie said: "Everything comes to those who wait, for but some it comes too late".

Posted by: Kay Tie | Aug 14, 2007 2:19:57 PM

"Marconi was once the jewel in the crown of British manufacturing."

It would be more accurate to call Marconi (nee GEC) the turd in the sandwich. Anyone who ever dealt with or worked at GEC knew just how shite they were. The kind of company that forced you to drive 120 miles to pick up a $200 foreign currency cash advance because "we get a slightly better rate than the bank right next to your office".

GEC was crap. Financially it was a basket case, giving a ROI of less than the interest earned on its cash pile (giving an enterprise value of less than zero). It was a useless company and would have died years earlier if not for Government defence pork. It served one purpose only: that of an employment grease trap that filtered useless wankers out of the job market and kept them from gumming up the pipes of good companies.

So can we PLEASE stop with the legend that GEC was a jewel.

Posted by: Kay Tie | Aug 14, 2007 2:29:34 PM

"So can we PLEASE stop with the legend that GEC was a jewel"

But I was _quoting_ city sources as posted on the BBC website!! And, besides, who owned GEC/Marconi shares and lost out with the collapse? A corporate loss of £5bn at the time of the collapse of Marconi was something of a record for Britain.

Believe me, I'm long familiar with the insight that GEC mainlined - as with drug addiction - on defence contracts which our Arnold would regularly wave in the news at opportune byelections for marginal seats.

All of which reminds me that Iain Duncan Smith, Conservative leader after William Hague, used to work as an executive for GEC after he left the army:

"He joined the Tory Party in 1981 - the same year he left the forces to make his way on Civvy Street. His first stop was the defence contractor GEC Marconi as a sales and marketing executive, a job that kept him in close touch with the military."

Posted by: Bob B | Aug 14, 2007 2:52:15 PM

"But I was _quoting_ city sources as posted on the BBC website!!"

Precisely why I have close to bugger all respect for the BBC as a news source. This blog provides vastly more insight (especially the comments from people with direct experience).

Posted by: Kay Tie | Aug 14, 2007 3:47:29 PM

But C'mon Kay - the BBC website is easy for readers to access and it wouldn't be too difficult to come up with quotes from other sources reflecting similar sentiments about GEC/Marconi and its demise.

The company may well have been run in a crap way but the company was a large, indigenous British company and it was held in popular esteem by many. Its origins date back to company mergers orchestrated by Weinstock during the Labour government of the 1960s when the inspiring vision was about the impending "white-hot heat of the technological revolution". The collapse of GEC renamed as Marconi, with losses of £5bn, came as a shock, which is what (understandably) motivated the quotes on the BBC website.

However, all this is a distraction from the main theme of this thread, which was about whether economists understand the movements of stock market prices and - if not - whether stockmarkets facilitate the efficient allocation of investment funds.

I quoted the well-known example of Warren Buffett to show that stock market investments are not necessarily and inherently irrational but then I could also have quoted this insight about the extent of rational motivation in the FOREX market:

"Nobel laureate James Tobin reports that one of his Yale students went to work for the Chicago Mercantile Exchange as an assistannt to an active trader who was a former economics professor. After a few weeks, the young man asked about the long-run calculations that governed the trades. He was told 'Sonny, my long-run is the next ten minutes.'"
Robert Solomon: Money on the Move (Princeton UP, 1999) p.14.

Posted by: Bob B | Aug 14, 2007 11:06:15 PM


Do read Martin Wolf's splendid take on recent stockmarket troubles in Wednesday's FT - subscription only, unfortunately.

Basically, the market turmoil is cathartic and a timely punishment upon all those financial institutions which lent money with insufficient diligence to bad-risk borrowers in times when real interest rates were kept artifically low by central banks.

He starts by quoting Bagehot with approval:

“At particular times a great deal of stupid people have a great deal of stupid money. . . At intervals. . . the money of these people – the blind capital, as we call it, of the country – is particularly large and craving; it seeks for someone to devour it, and there is a ‘plethora’; it finds someone, and there is ‘speculation’; it is devoured, and there is ‘panic’.”

Admittedly, it's an intriguing piece of economic analysis these days which is predicated on the supposition that our capital markets are beset by a lot of stupid agents. I wonder if we will have the joy of reading rejoinders on this from our many friends in the city. It harks back to Alan Greespan's comments of c. 1996 about "irrational exuberance".

Posted by: Bob B | Aug 15, 2007 11:39:49 AM