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The illogic of financial markets

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I have worked at stock exchanges and thought many years about markets.  Much of what is said about them–even by leading economists–is rubbish.   Indeed, the salient idea is rubbish–that people can rationally select wise investments.  The logic to disprove it is straightforward, but experience is even better. We all have such experience.

Here’s a statement of the issue succinctly put by the very good Baseline Blog:

But I have one major reservation, which is that I’m not sure how good the financial advice would be. In my opinion, most financial advice floating around is worth less than nothing. To take the most obvious example: by sheer volume, the largest proportion of financial advice that exists (counting all advice that anyone gives to anyone else via any means of communication) is almost certainly advice on buying individual stocks, and the second largest is probably advice on choosing mutual funds. I am firmly in the camp that believes that whether or not stocks obey the efficent market hypothesis, it is not within the capabilities of any individual investor to identify stock trades that will have an expected risk-adjusted return higher than the market as a whole, net of transaction costs. I also believe it is not in within the capabilities of any stock mutual fund manager, and that all of the variation in risk-adjusted mutual fund performance can be explained by pure statistical variation. And even if I’m wrong about that, and there are a few exceptional fund managers out there, I don’t believe that any individual could distinguish the exceptional managers from the simply lucky ones; and even if he could, by the time he did he would be buying into a fund that had grown so big it was no longer capable of above-market returns.

It’s a point I’ve made many times in similar form with no refutation from leading institution-trained economists and others.  The real kicker is also made by the Baseline Blog.  That is, if this weren’t so…markets should solve the problem!  And I’ll take that one step further, if THAT weren’t so, then why would anyone having the capacity to invest wisely, which would be invaluable, not sell it as a commodity at extremely high markups–essentially risk free, rather than running a hedge fund, mutual fund or even their own portfolio.

It’s a fool’s game.   The pricing system simply doesn’t work.  The current global financial crisis shows just how destructive things can get when widespread belief in a myth becomes a way of life.

By the way, the same logic applies very well to starting businesses or making other key life choices.  Without global objectives that are pre-set and socially agreed, optimal selection of investment options is extremely unlikely.  That’s why rich people live in planned communities and poor people live in ad hoc ghettos.


Written by ryanlanham

January 25, 2009 at 2:28 pm

Energy accounting

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Technocracy, Inc. has done a good job of advancing the concept of energy accounting.  There are aspects of Technocracy, Inc. that seem too controlling and too “organizational” to suit my Web-based collaborative inklings.  But they’ve done a lot of good and wikipedia reflects a lot of hard work by the organization.  The energy accounting entry is a good example and an excellent primer for budding technocrats.

Written by ryanlanham

January 10, 2009 at 2:54 pm

Mike Hewitt on the history of paper money

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Dollar Daze (Mike Hewitt) has a worthwhile article on the history of paper money I found on the Safehaven blog.  Good stuff…and a bit disturbing with regard to the operations of the pricing systems based on government currencies, in general.

Written by ryanlanham

January 7, 2009 at 6:14 pm

Brad Setser Chronicles the Decline of Globalization in Financial Terms

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At the Council on Foreign Relations, Brad Seltser chronicles the decline of financial globalization.  What would a technocrat do?  One thing is to minimize dirigisme that beggers neighbors and to look for opportunities to reward participants in global free trade.  Pricing systems will not do this in the short term.  Another factor that must be addressed is some concept of how much a nation may borrow and how much a nation may lend.  There ought to be technocratic guidelines at minimum.  Pricing seems not to work.  Rating agencies are risible.

Can we be far from a global currency?  How would that work?  How would money be created?  What would stand behind global value?  Without trust…the destroyed ingredient in the current crisis, what can be done?

Written by ryanlanham

January 7, 2009 at 3:28 pm

NY Times OpEd on the Financial System Ending as We Know It

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I just read Barry Ritholz’s coverage of  the entire OpEd section of the Sunday New York Times being taken over by an article written by Michael Lewis and David Einhorn.  The article is called “The End of the Financial World As We Know It.”  Everyone will be covering it, but it’s important stuff.  I didn’t find anything particularly new there, but it is a well-stated indictment of the pricing system.

Written by ryanlanham

January 4, 2009 at 3:12 pm

Reuters: US governors need a trillion for their states

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Things continue to go swimmingly in the US.   Several states, Arizona, California, Florida and others like NY, are on the verge.  Here’s their plea for bailout from Reuters.

Basically value in the economy is based on an oversupplied asset: retail housing.  Pricing failed us again.  It inherently moves…and sometimes it even moves down.

Written by ryanlanham

January 3, 2009 at 9:35 pm

Dying economic theories…

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Chad Orzel offered a link to John Quiggen’s interesting series on refuted theories of modern economics and finance.  Worth following.

In the second entry, Quiggen deals with the muddled logic economists and libertarians use for supporting privatization.

Written by ryanlanham

January 3, 2009 at 3:38 pm