One of the favourite books is Extraordinary Popular Delusions and the Madness of Crowds. It was published way back in 1841 but the lessons for traders are timeless. It shows how simple, misguided ideas can ruin economies for generations.
“US housing prices will always rise”
More than anything, that idea led to the credit crisis. In retrospect, it’s utterly baffling but economists were preaching it even as the walls were crumbling on the real estate market. They repeated it as if it were the law of gravity. That’s how closely people (and markets) can hold onto popular delusions.
At the moment, society is incredibly deluded. Ideas spread so quickly and become universally accepted and believed.
A mania at the moment is the value of a university education.
Young people are going into tremendous debt because of the myth that people who go to university will earn more over their lifetimes. This was true 20+ years ago but supply has now exceeded demand and a gigantic bubble in student debt will cripple future generations. The WSJ explores the issue in an article just published:
The comeback always is college graduates make vastly more than those with high-school diplomas. True. But that is comparing apples and oranges. College graduates, on average, are smarter and more disciplined and dependable than high-school graduates—so much of the reported earnings differential has little to do with college learning.
Moreover, supply has created its own demand—as we flood the market with college graduates, even bars demand bartender applicants have a degree. We have engaged in massive and costly credential inflation to certify competency for jobs. College is still a good deal for some, but not for many others.
People will hang onto this idea for many years to come.
But the overarching delusion that will define the 21st century is modern economics. People worship at the gospel of economics. The same PhD’s who missed every warning sign of every crisis are hauled out to advise Presidents, Prime Ministers and make policies.
A great trader named Colm O’Shea explains the problem in Hedge Fund Market Wizards.
A grad student showed me a notebook full of ridiculous equations proving his obscure theory. To me, economics is no more mathematical than medicine. You can’t explain the human body with an equation; and you can’t explain mass human behaviour with an equation.
The whole mathematical model is built on the theory that people will do what’s in their best interest. It’s nonsense but guides virtually every policy decision in the world.
This is the endgame. Some of the ideas are wonderful. At its core, capitalism is the best system but economic dogmatism has built a disastrous currency union and is allowing nations to accumulate debt that will hinder far wiser future generations.
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