Why Do Conservatives Loathe Keynes?
One reason conservatives loathe Keynes is his view of financial markets:
The social object of skilled investment should be to defeat the dark forces of time and ignorance which envelop our future. The actual, private object of the most skilled investment today is to “beat the gun”, as the Americans so well express it, to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow.*
Keynes thinks that the real value of an asset is based solely on the stream of income it will produce, and that the social purpose of investing is to determine that stream as accurately as possible. He then explains that the financial markets don’t do that at all. Among the reasons he gives are the following:
1. There are a lot of ignorant amateurs in the market, who lack the time and skill necessary to value securities.
2. The normal fluctuations in the day-to-day profitability of businesses play too great a role in the estimates of value by casual investors.
3. If conventional valuations are based on crowd psychology, they are subject to greater fluctuations than the opinions of professional investors. Volatility creates greater risks for professionals.
4. Professional investors cannot exploit the incorrect long-term valuation of the crowd, because crowds can be stupid longer than professionals can stay solvent.
5. Professional investors are in large part dependent on the willingness of banks to lend them money, which means that their ability to do their socially useful thing is dependent on the views of people who don’t know anything about what the professionals are doing.
These factors mean that markets don’t allocate capital rationally either: “When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.” ** That is precisely the state of things today. For all the boasts of Lloyd Blankfein, trading produces well over 50% of the revenues of Goldman Sachs, and has for years. Where is investment in future production for this country?
This paper shows the mechanism by which Keynes’ views operate: Noise Trader Risk in Financial Markets, J. Bradford DeLong, Andrei Shleifer, Lawrence H. Summers and Robert J. Waldmann, 1989 rev. The paper is worth reading for the way it uses equations to illuminate the thinking of the authors, rather than to obscure it. We start with a definition:
Noise traders falsely believe that they have special information about the future price of the risky asset. They may get their pseudo-signals from technical analysts, stock brokers, or economic consultants and irrationally believe that these signals carry information. Or they may, in formulating their investment strategies, exhibit the fallacy of excessive subjective certainty….
Id. at 6. The paper shows that in certain circumstances, noise traders can achieve better returns than investors looking at fundamentals. The reason for this anomalous result is that noise trading creates risks, which drives away professionals who would otherwise try to profit from arbitrage:
… our point is that noise traders can earn higher expected returns solely by bearing more of the risk that they themselves create. Noise traders can earn higher expected returns from their own destabilizing influence, and not because they perform the useful social function of bearing fundamental risk.
Id. at 5. This, of course, should have been a giant nail in the coffin of the Efficient Market Hypothesis, but, equally of course, it wasn’t. I googled the term, and this is the first thing that came up, some guy explaining investing based on the EMH.
Conservatives cling to faulty propositions like the Efficient Market Hypothesis long after they have been exposed as tripe. Partly they need to hold on because it protects their fragile egos from the need to change their ideology. But the real problem is that the policy recommendations of the people who got it right will cost them money, either by restricting their anti-social activities or by increasing their taxes. Either way, their dominance of the discussion hurts the rest of us.
*Keynes, The General Theory of Employment, Interest, and Money, Prometheus Books, p. 155.
**Keynes, at 157.