The Wisdom Of The Crowds

My friend Lars tried an experiment last week:

The Crowd: “Lars, you are fat!”

On Friday I was doing a presentation on the global economy (yes, yes mainly on global monetary policy) for 40-50 colleagues who are working as investment advisors in the Danske Bank group.

As I was about to start my presentation somebody said “The audience have been kind of quiet today”. I thought that was a challenge so I immediately so I jumped on top of a table. That woke up the crowd.

I asked the audience to guess my weight. They all wrote their guesses on a piece of paper. All the guesses were collected and an average guess – the “consensus forecast” – was calculated, while I continued my presentation…

I’ve done something of the same sort in some of the classes I used to run. It’s a great way to get audience participation, and to illustrate abstract economic concepts in real world settings. But Lars’ attempt was a lot funnier than mine. While I won’t hold this as proof positive that the efficient market hypothesis is valid under all circumstances, there is more than a grain of truth in it.

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.

Links of the Day

Esther Duflo says we can't trust bankers:

"There is another argument, implicit or explicit, for the nationalisation of banks; we can not trust bankers not to leave with the cash, let alone spend any assistance whatsoever in the general interest. Two recent studies that analyse the experience of recent years show that they will not hesitate to enrich themselves at the expense of the public good if they have the opportunity."

Willem Buiter offers a stinging critique of modern macroeconomics:

"In both the New Classical and New Keynesian approaches to monetary theory (and to aggregative macroeconomics in general), the strongest version of the efficient markets hypothesis (EMH) was maintained. This is the hypothesis that asset prices aggregate and fully reflect all relevant fundamental information, and thus provide the proper signals for resource allocation. Even during the seventies, eighties, nineties and noughties before 2007, the manifest failure of the EMH in many key asset markets was obvious to virtually all those whose cognitive abilities had not been warped by a modern Anglo-American Ph.D. education."