After the boom

John Quiggin

The third anniversary of the peak of the NASDAQ boom has produced a fair bit of commentary. As an economist, I think the biggest impact, still only dimly-perceived, is the refutation of the efficient markets hypothesis.

I’ll start with the introduction from a piece I wrote for the Fin last year, which ran under the titleMarket theory unravels

Although the name gives the general idea, the efficient markets hypothesis is hard to state in simple terms. To complicate matters further, the hypothesis comes in a variety of intensities, from weak to very strong. The weakest version simply says that it is impossible to predict shares prices based on their past behavior. This is bad news for day-traders and chartists, but does not matter much to the rest of us.

In the strongest version of the efficient markets hypothesis, market prices for assets such as shares represent the best possible estimate of their value, taking account of all available information, public or private. Moreover, markets yield the most efficient possible allocation of risk. Markets are not perfect, but, they are claimed to be better than any alternative institution, including governments.

Although the statistical evidence generally doesn’t support strong versions of the efficient markets hypothesis, statistical testing is never going to finally refute an idea that’s so obviously appealing to a lot of people.

But I think the experience of the NASDAQ bubble has fatally undermined the efficient markets hypothesis, for several reasons.

First, in terms of scale, financial magnitude and worldwide publicity, it was far bigger than any previous bubble. Trillions of dollars in market capitalisation were lost and at least one trillion dollars was dissipated in investments that ranged from unsound to absurd. Millions of individual investors made and lost large amounts of money.

Second, it was widely recognised and denounced as a bubble, even as it developed. Here’s a piece I wrote in 1999 criticising dotcoms in particular, but the speculative nature of the boom had been recognised as early as 1996, when Robert Shiller coined, and Alan Greenspan popularised the phrase ‘irrational exuberance’.

Third, all the ‘checks and balances’ that are supposed to prevent a bubble were present and all were ineffectual or counterproductive. It’s hard to recall, but there was a time when people believed that stock market analysts served a positive role in informing financial markets. Accountants, debt rating agences and regulators have been as thoroughly discredited as analysts, but all clearly failed to their job.

Most notable of all, but less noticed was the failure of counter-speculators to burst the bubble. George Soros lost billions in 1998 and 1999 by short-selling stocks that were grossly overvalued. By the time the bubble reached its peak three years ago, the bears had all retired to lick their wounds – it was only when the bulls finally ran out of money that the madness stopped.

The implications of rejecting the efficient markets hypothesis are profound. As I observed in the AFR piece quoted above

Judging by the experience of other bubbles, share markets will take years to recover from the 1990s. The social and political implications will emerge even more slowly. Political programs like privatisation, cultural attitudes based on the idolisation of ruthless CEOs, and much of the ideological framework of the last two decades have been founded on the efficient markets hypothesis. They will not vanish overnight. But they are doomed, nonetheless.

Hypocrisy on Iraq and Indonesia

John Quiggin

The pro-war case sinks to a new low in today’s Oz. David Martin-Jones wants to nail Australian opponents of war with Iraq with hypocrisy because they supported intervention in East Timor without UN authorisation. The only problem is he can’t find anyone to pin the tag on, apart from unnamed Sydney demonstrators who accused Howard of being “In bed with genocide” (a slogan which could equally refer to Australia’s long-standing complicity in the illegal occupation of East Timor), and (also unnamed) figures in the ALP who wanted Howard to “do something”. As far as I know, no significant public figure in Australia advocated a military intervention to forcibly eject the Indonesians, even in the period of militia rampages after the referendum, and of course, the actual intervention took place only after the Indonesians had announced their withdrawal.

In fact, it’s Martin-Jones who’s the hypocrite here. Suharto was an evil dictator who invaded a neighboring country in defiance of the UN and murdered hundreds of thousands of people in both Indonesia and East Timor. The moral case for an invasion to overthrow him was just as strong as the case against Saddam, but we didn’t hear it from Martin-Jones or, as far as I know, from anyone currently supporting war. Of course, the practical arguments against an invasion were so overwhelmingly strong (militarily risky, bound to generate hostility in the region and resentment of occupying forces, likely to lead to the breakup of the country etc) that no-one even contemplated it, but people like Martin-Jones contemptuously dismiss similar concerns in relation to Iraq.

(As someone will doubtless point out, there’s still the separate issue of WMDs, but the US case here has fallen to pieces – the only reasonable argument for invasion is based on the nature and history of Saddam’s regime).

The quiet anti-American

John Quiggin

In a post entitled America and the Left, Ken Parish has returned to the theme that, in criticising the Bush Administration, I am taking an anti-American line. I should note before going any further, that Ken has posted a comment to the effect that he regrets the personal nature of his criticism. However, he doesn’t withdraw the basic claim that, if you oppose the foreign policy of the US government all or most of the time, you are anti-American.

As Ken correctly says, of US governments since 1960, the only ones whose foreign policy I agreed with were those of Carter and Clinton (I should add that my judgement of the Kennedy administration is purely retrospective. I’m just old enough to remember where I was when Kennedy was shot, but I’m pretty sure I’d never heard his name before that day).

I could quibble with this in a number of ways. For example, I’m on the record as an admirer of both Eisenhower and FDR, and I have mixed opinions about Truman, so if I can start the clock in 1932, I come out almost exactly neutral. If you add in domestic policy, where I admire LBJ, I can just about qualify as pro-American.

But the main point is that Ken’s whole position (one that is shared my many supporters of the current US Administration) is nonsensical. I’ve had strong opinions about Australian politics for over thirty years. For all but three of those years I’ve been more critical of the government than supportive (and even in those three years my feelings were mixed by the end). I’ve publicly attacked governments of both parties, week in and week out, for the last decade, and have been attacked with vigour in my turn. In that entire time, as far as I can recall, no-one has ever accused me of being anti-Australian or unAustralian, and I’m sure that no-one who made such a claim would be taken seriously.

A government, even a democratically-elected one, is not the same as the country it governs. Both citizens and non-citizens can oppose the policy of a government without being hostile to the country it governs

Red herrings

John Quiggin

It had to happen. An ex-dotcommer, the former editor of recently-folded dotcom hypemag Red Herring, has decided the time is ripe to make money out of blogging.. His site, called AlwaysOn, is pretty much what you’d expect to have seen if blogs had been around in 1998 and someone trolling for $20 million to produce a slick commercial version had produced a ‘proof of concept’. I can’t believe that there’s anyone left out there in VC-land stupid enough to throw $20 million at a blog, but if there is, I want to be first in line.

Be afraid

John Quiggin

Writing in the New Republic Peter Beinart says:

On the subject of North Korea, there are two groups of people in Washington today: People who are terrified, and people who aren’t paying attention. Unfortunately, the latter category seems to include the president of the United States.

I’ve been in the terrified/horrified camp for some months, during which time things have drifted from bad to terrible. Beinart, recently, described as a full-fledged, talon-baring hawk on Iraq backs up his diagnosis of attention-deficit disorder with the observation

the diplomatic reality is that there is no united front. North Korea adamantly rejects multilateral talks, and South Korea, Russia, and China adamantly refuse to turn the screws. The Bush administration is paying the price for having helped fuel the anti-Americanism that elected an ultra-soft-line president in Seoul last December. And it cannot pull out all the diplomatic stops with Moscow and Beijing since its highest priority is convincing those governments not to veto an Iraq resolution at the Security Council. The unhappy result is that the United States is basically facing this crisis alone. (emphasis added).

Beinart concludes

If the Bush administration does understand that it will eventually have to sit down with Pyongyang, then its current delay represents the inexcusable privileging of politics over national security. If, on the other hand, it has no intention of engaging in such talks, its current stalling tactics may stem from a very different calculation: That the United States can only fight one war at a time. As Stanley Kurtz put it approvingly recently in National Review Online, “If our policy is to strike when we may and must, silence makes a good deal of sense.”

This has so far been too chilling an interpretation for most observers. But, in either case, the United States is much closer to the brink than most Americans realize. And, whether out of political self-interest or ideological zeal, the Bush administration doesn’t seem to mind.

I don’t think the NRO analysis cited by Beinart holds up at all. A war with North Korea would be incomparably more dangerous than anything Saddam Hussein could do, and the danger grows every day. If war with North Korea is planned, or even contemplated, any competing policy priority should be dropped immediately. Every asset the US has, military, economic and diplomatic, should be devoted to achieving a victory in which the North Korean government doesn’t use its nuclear weapons and to achieving the victory as soon as possible, before any more weapons are produced.

Given that this clearly won’t happen, I can only hope that the Administration is planning to buy the North Koreans off. A minimal silver lining in this generally gloomy situation is that a victory over Saddam might give Bush enough political points to cover a craven backdown to Kim-Jong Il – at this point there seems to be no alternative.

Update Ultra-hawk Charles Krauthammer takes precisely the line I’ve suggested on North Korea. He even uses the dreaded A-word “appeasement”. Krauthammer covers himself by saying “it would only be temporary appeasement”, but the North Koreans, like the Turks, are sure to demand cash up front. As Paul Krugman pointed out a while back, no sensible person deals with the Bush Administration on any other basis.

Monday Message Board

John Quiggin

There are a lot of anniversaries at present. We covered the 20-year anniversary of the Hawke-Keating government pretty thoroughly last week, but didn’t get to the 7-year anniversary of the Howard government. And it’s 3 years today since the bursting of the NASDAQ bubble. So, I’m inviting any thoughts on these anniversaries before I try to post my own later in the week.

As always, feel free to comment any issue, civilised discussion and no coarse language please.

Come on, guys! Monday evening and no comments at all. I’m disappointed!

Compromise of Straw

John Quiggin

The following is the text of the British amendment to a second resolution to the U.N. Security Council demanding that Iraq disarm:

Determined to secure full compliance with its decisions and to restore international peace and security in the area,

Acting under Chapter VII of the Charter of the United Nations,

1. Reaffirms the need for full implementation of resolution 1441 (2002);

2. Calls on Iraq immediately to take the decisions necessary in the interests of its people and the region;

3. Decides that Iraq will have failed to take the final opportunity afforded by resolution 1441 (2002) unless, on or before 17 March 2003, the Council concludes that Iraq has demonstrated full, unconditional, immediate and active cooperation in accordance with its disarmament obligations under resolution 1441 (2002) and previous relevant resolutions; and is yielding possession of UNMOVIC and the IAEA of all weapons, weapon delivery and support systems and structures, prohibited by resolution 687 (1991) and all subsequent relevant resolutions, and all information regarding prior destruction of such items;

4. Decides to remain seized of the matter.

Assessment Obviously this gives the US automatic authorisation to go to war simply by vetoing any resolution consistent with the terms of Item 3. Hence, it is simply a mean and tricky version of the previous draft, which itself was weaselly in its failure to include an explicit an authorisation of war. The obvious countermove is a resolution imposing specific demands on Iraq in place of what is in effect a demand to satisfy George Bush.

My top 5

John Quiggin

Given that I just reread High Fidelity, I can scarcely refrain from the current trend for listing a top 5 group of referrers. My stats counter only gives this ranking on a “lifetime’ basis, so I need to aggregate across various incarnations of the same blog, and this makes the actual ranking a bit tenuous.With that caveat regarding order, my all-time top 5 referrers are:
Jason Soon;
Tim Dunlop;
Ken Parish;
Steven Den Beste; and
Me;

The first three don’t surprise me, and shouldn’t surprise anybody. These are the blogs I read most regularly, link to most often, comment on most frequently and generally regarded as my closest neighbours in the virtual world of Ozplogistan. Den Beste’s is the only one of the top-ranked US blogs I comment on with any frequency (generally critically) and he occasionally replies. Since he has about 50 times as many readers as I do, this invariably produces a huge but short-lived spike in visitor numbers – I guess the majority of USS Clueless fans are unlikely to become permanent readers of my blog.

Finally, when I started the blog I saw it in part as an exercise in cross-promotion with my website, and it has succeeded in this respect – I get more visitors to the website and a steady flow of referrals back to the blog. I didn’t realise, of course, that moving from running a website to running a blog was like going from marijuana to crack cocaine, but it’s too late now.

What I'm reading

John Quiggin

What I should be reading is Magill and Quinzii Incomplete Markets, an excellent work on finance theory that drops the usual assumptions of perfect rationality and complete markets. Of course, this is just the time when I decide it would be a good idea to reread the complete works of Nick Hornby and watch the movie versions for purposes of comparison. So far we’ve all watched the movie of Fever Pitch and I’ve reread most of it, as well as High Fidelity.