Free markets are the most efficient capital allocators known to man. But the real reason this is significant is the recent paper by Dhananjay K. Gode and Shyam Sunder. It’s a study of trading and efficient markets. The conclusion blows a gigantic hole in the behavioural economic view of market theory. The study used both humans and computers to trade a market, and measured profit and loss performance.
It wasn’t concerned over who made money and who didn’t, but was concerned about if the market allocated capital efficiently, and if the market worked efficiently to allocate capital even if the participants didn’t seek to maximise profits. That’s a key point because behaviorists will say markets are irrational because investors are not acting in their own best interests. That irrationality causes misallocations of capital, making efficient market theory incorrect.
This study proves that the behaviorists are incorrect.
Eugene Fama postulated the Efficient Market Hypothesis back in 1964. He has had to allay the slings and arrows of several finance academics and economists, but every single time the data backs him up. You can’t beat the market. The average individual will do better in the long run investing in a no load, no fee mutual fund that replicates the S&P 500. ($ES_F, $SPY)
Why is this important to you? Because the current administration has embraced behavioural economics as gospel. Cass Sunstein co-authored the book Nudge, and he is the regulator in chief of the Obama administration. Even today’s Wall Street Journal says, “ObamaCare’s partisans claim none of this will happen because of the social norm theories of behavioural economics.”
Obama is remaking the entire regulatory map using economic theory that doesn’t work. If you really understood behavioural Economics, you would know that on the surface, it’s pretty compelling. But underneath, there is a slippery slope to total government control over everything. Why? Because behavioural Economics presumes that the individual doesn’t know better and we have to set up structure for them to operate in. That structure limits choice(freedom) to protect us from ourselves. It’s “Nanny Knows Best” economics.
True free market economics in the Adam Smith vein has a lot of warts. It’s messy. People make mistakes. Sometimes it takes a bit longer for a market to clear. There are winners and losers. Many will point to things as being unfair. But, it’s the most efficient way to allocate capital and to raise the standard of living for all society.
There is no getting around it, people intrinsically weigh opportunity costs/benefits and make utility maximizing decisions for themselves. That’s what makes the world go round. Some people are able to process information quicker than others, are smarter than others, and have more material advantages than others-but that playing field has been with us since the dawn of mankind. There is no way to even it.
The internet has made it possible to have true worldwide markets. It’s possible to quickly exchange information and act on it across borders and time. Simply look at the speed at which news travels today versus even 10 years ago. It’s much faster and more efficient. You don’t even need to watch television news anymore, just follow the right people on Twitter.
Demand curves always slope down. The study concludes, “Adam Smith’s invisible hand may be more powerful than originally thought….it may generate aggregate rationality not only from individual rationality but also from individual irrationality.”