Shorting Reason

Richard Posner has a good review of Animal Spirits by George Akerlof and Robert Shiller. Here’s a snippet:

As one reads this book, one has the sense that deep down Akerlof and Shiller believe that being rational is the same as being right. That is a mistake. It prevents them from entertaining the possibility that what has now plunged the world into depression is a cascade of mistakes by rational businessmen, government officials, academic economists, consumers, and homebuyers, operating in an unexpectedly fragile economic environment, and that what is retarding recovery is not the “unreasoning fear” of which Franklin Roosevelt famously spoke but the rational fears–the reasoning fear, to use Roosevelt’s idiom–of businesspeople, consumers, and officials who confront economic uncertainties for which no one had prepared them.

I’ve often been critical of Robert Shiller’s work because I think he places too much emphasis on the short comings of investors. It’s true that folks often get carried away with things especially when prices get moving.
The truth is that many times it has been “different this time” or we did “enter a new era.” The speculation usually comes after a major change has taken place. Asset prices don’t easily confirm to a simple morality tale of people getting greedy and overpaying for stuff. If you scratch the surface, you’ll see that there are many concrete reasons (and government policies) that caused the animal spirits.
Just to give one example is that bubbles can often be confirmed by popular memes. The Nifty Fifty craze of the early 1970s specifically focused on companies that fostered social harmony (Xerox, McDonalds, Coke, Polaroid, Disney) which was a natural inclination after the turbulent 1960s.
The bubble of the 1990s seems to have been aided by the growth of the dubious first-mover-advantage theme. I remember being told countless times how some dot-com stock was “just like QWERTY.”
The story was that once a company became an industry standard, it would be the winner that took all. There was even a magazine called the Industry Standard. In 2000, the magazine sold more advertising than any magazine in America.
It didn’t last.

Posted by on April 5th, 2009 at 10:46 pm


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