Thursday, May 6, 2010

Scott Sumner Takes A Shot At China Bears

…not for being wrong, but for being disingenuous (excerpt):

Plato would not be impressed

"I’m not impressed by predictions that assume the EMH is wrong. But I am willing to keep an open mind on the EMH. I am especially unimpressed with predictions that assume the EMH is wrong and that are based on false or misleading economic statistics. If those predictions turn out to be accurate, it would not make me think more highly of the person who made the prediction, I’d just assume he got lucky.

I understand that predictions are fun, and it’s only human to want to anticipate what will happen next. I’m all for making conditional predictions based on various public policy options. And I’m all for drawing inferences regarding the implied predictions embedded in asset prices. But the sort of unconditional predictions discussed in the Bloomberg article should be placed in the astrology section of the newspaper. Fun to talk about, but not to be taken seriously."

EMH by the way is the Efficient Markets Hypothesis. While I’m inclined to lean against the EMH being right, statistically speaking it’s not very easy to prove or disprove.

In any case I would not have structured an argument against China bears in terms of EMH anyway – I think it is less than useful to frame analysis of developing countries, particularly one as dynamic and as diverse as China’s economy is, in terms of the equilibrium conditions in developed economies. That is, the dynamics and interaction of money, debt, growth and asset markets are radically different between an economy on its production frontier, and one that is attempting to reach it.

For the same reason, I find it difficult to fault China’s management of its currency – you cannot directly take an economy with deep and broad financial and capital markets that are capable of withstanding volatility and massive capital flows, then make judgements on what monetary policy should be followed in a country with a relatively weak and unsophisticated banking system. Financial liberalisation in developing countries has almost always been followed by financial crises, not just in East Asia but pretty much across the globe (Mexico, Russia, Turkey to name a few). China’s heavy-handed approach to managing its currency and banking system may not be optimal in Western eyes, but it is governed by necessity.

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