How many economists need to work for how long to bring about a global meltdown? About a century and almost the entire faculties of at least a half a dozen universities.
Having done that, do they have the ability to put the world back together again? That we will not know in a hurry in a global financial order staving off the possibility of a second dip recession.
The whodunit from Justin Fox of Time magazine makes the events of 2008 a sort of denouement to the build up from the ?efficient market hypothesis? propped up by economists over the past hundred years. Written like a thriller, with a Dan Brown touch, this is possibly raciest among all the books that have emerged from the debris of the global financial collapse. The Myth of the Rational Market spares just no one from the cast of a century-odd lot of economists.
The thriller takes off from the first chapter where Irving Fischer loses a valise from a phone booth in New York in 1905. Fox maintains the pace to arrive at Lehman Brothers in 2008. Quite appropriately, the book has a ?cast of characters? at the end to make the readers remember the plot. If Freefall by Joseph Stiglitz, also given a detailed build-up in the Fox thriller, is a detailed forensic report, The Myth… is a build-up to the crime.
To build up the atmosphere, Fox has not sacrificed details. The book is long, over 329 pages. In each chapter, he has painstakingly built upon the theories of the Chicago school, the Keynesian foot soldiers and the supporting role played by the London School of Economics. To coalesce all that into a narrative is a big deal. One of the very good props Fox has used is the historical narrative structure, where he has used plenty of anecdotes and given a personality to the clashes of economic thought. This has to connect the economists and their thoughts without over-simplifying the theories which they have worked on.
?In the spring of 1979, just after the publication of their ‘Prospect Theory’ article, Daniel Kahneman and Amos Tversky visited Richard Thaler at the University of Rochester. Thaler arranged a dinner for his guests and, somewhat mischievously, seated Tversky next to efficient markets apostle Michale Jensen. The exchange that resulted, recalled Thaler’s Rochester colleague Hersh Shefrin, who was also at the table, ?kind of set the tone for the debate over the next 15 years?.
The psychologist could not resist springing one of his quizzes on the finance professor. Tversky asked Jansen to describe how his wife made decisions. Jensen regaled him with tales of her irrational behaviour. Tversky asked Jensen what he thought of President Jimmy Carter. An idiot, Jensen said. And what about the policies of the Federal Reserve chairman? All wrong. Tversky continued listing decision makers of various sorts, all of whom Jensen found wanting. ?Let me see if I’ve got this straight?, Tversky finally said. ?When we talk about individuals, especially policy makers, they all make major errors in their decisions. But in aggregate, they all get it right?.
Obviously, he has had to cut back the full rigour of the multi-faceted contribution made, especially by economists Schumpeter, Paul Samuelson and Milton Freidman. But that would have cut the speed of the narrative. In the process, of course, they do seem uni-dimensional at times, which, therefore, makes it almost as if they were working on a pre-assigned plan, as if to unleash the efficient market paradigm on the world.
And that is where one could quibble. The worldwide collapse had, among many things, significant misjudgments of the role of the market, but to trace it all back to the economists is a bit of a stretch. At the best of times for Keynesian economics in the 1960s, for instance, the space available for the economists in public policy was very limited. That picture has got repeated in later decades too. Outside the USA, in UK, Europe or Asian economies like India, economists were only able to influence the overall conduct of the monetary policy, while the fiscal has often remained tied to the needs of the political class. A favourite grouse of the economists has long remained the lack of space to experiment their thesis and the present crisis has not been an exception. So the Wall Street firms, when they used some of those theories, were often taking them out of context, particularly those crafted often as riposte to the planning dogma unleashed by the disastrous love affair with socialism in some parts of the world through the better part of the 20th century.
The mathematical models built up by the smart financial whizkids, especially from the Chicago school, were the lead runners, but the conditions were already in evidence in the Eighties of the last century. For instance, were the economists really responsible for the packaging and repackaging of risks by the Wall Street firms to develop the opaque CDOs and SIVs that ran riot in the mortgage market? If they provided the intellectual climate for these instruments, as Fox claims, it is difficult to reconcile how two opposing prescriptions could produce the same disaster with an 80-year gap.
At the peak of the Great Depression of 1929, more jobs were wiped out, men committed suicide and the world hurtled towards the apocalypse of the second World War, compared to the debris of 2008. But the chief causes then, as now, were the same misreading of the bubble by the Fed.
As Milton Friedman pointed out, 1929 happened as the Fed tightened too fast; but 2008 happened because the Fed did not. The European crisis that has now unfolded after the book came out has, meanwhile, little to do with the efficient market hypothesis, though it has precipitated by the disturbances in the global economy. But in Europe, the culprits from Greece to Portugal and Spain remain the governments, which did just as Wall Street behaved, as if there is no tomorrow.
