Welcome to the Dark Side
After discussing the absurdity of the capital-rich United States being by far the world’s biggest borrower and biggest debtor, Brad de Long observes
it is a Dark Night of the Soul for us neoclassical economists who believe in the long run and in the even partial rationality of international capital flows.
I went through the necessary loss of faith a few years ago. As I observed last October
If you accept that the $US has to depreciate at some time, then holding bonds denominated in $US, and receiving interest rates lower than those obtainable in other currencies, is a dumb idea. Unless you think either that European governments are likely to default on their debt or that euroland is poised for inflation, eurobonds are a better bet, and similarly for Australian government bonds denominated in $A. But I’ve given up even the residual belief in the efficient markets hypothesis that would lead me to try and work out a coherent explanation of perverse asset prices. (Emphasis added)
Despite the stunning contrary evidence of the past five years, residual belief in the idea of efficient capital markets continues to shape the thinking of most economists (including me, when I let myself be guided by instinct rather than careful reasoning). Only when we have freed ourselves of this incubus will we able to make progress in understanding the global economy. Because this is akin to a loss of religious faith it will be a difficult and painful process.