Most Popular
1. Banking Crisis is Stocks Bull Market Buying Opportunity - Nadeem_Walayat
2.The Crypto Signal for the Precious Metals Market - P_Radomski_CFA
3. One Possible Outcome to a New World Order - Raymond_Matison
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
5. Apple AAPL Stock Trend and Earnings Analysis - Nadeem_Walayat
6.AI, Stocks, and Gold Stocks – Connected After All - P_Radomski_CFA
7.Stock Market CHEAT SHEET - - Nadeem_Walayat
8.US Debt Ceiling Crisis Smoke and Mirrors Circus - Nadeem_Walayat
9.Silver Price May Explode - Avi_Gilburt
10.More US Banks Could Collapse -- A Lot More- EWI
Last 7 days
Stock Market Volatility (VIX) - 25th Mar 24
Stock Market Investor Sentiment - 25th Mar 24
The Federal Reserve Didn't Do Anything But It Had Plenty to Say - 25th Mar 24
Stock Market Breadth - 24th Mar 24
Stock Market Margin Debt Indicator - 24th Mar 24
It’s Easy to Scream Stocks Bubble! - 24th Mar 24
Stocks: What to Make of All This Insider Selling- 24th Mar 24
Money Supply Continues To Fall, Economy Worsens – Investors Don’t Care - 24th Mar 24
Get an Edge in the Crypto Market with Order Flow - 24th Mar 24
US Presidential Election Cycle and Recessions - 18th Mar 24
US Recession Already Happened in 2022! - 18th Mar 24
AI can now remember everything you say - 18th Mar 24
Bitcoin Crypto Mania 2024 - MicroStrategy MSTR Blow off Top! - 14th Mar 24
Bitcoin Gravy Train Trend Forecast 2024 - 11th Mar 24
Gold and the Long-Term Inflation Cycle - 11th Mar 24
Fed’s Next Intertest Rate Move might not align with popular consensus - 11th Mar 24
Two Reasons The Fed Manipulates Interest Rates - 11th Mar 24
US Dollar Trend 2024 - 9th Mar 2024
The Bond Trade and Interest Rates - 9th Mar 2024
Investors Don’t Believe the Gold Rally, Still Prefer General Stocks - 9th Mar 2024
Paper Gold Vs. Real Gold: It's Important to Know the Difference - 9th Mar 2024
Stocks: What This "Record Extreme" Indicator May Be Signaling - 9th Mar 2024
My 3 Favorite Trade Setups - Elliott Wave Course - 9th Mar 2024
Bitcoin Crypto Bubble Mania! - 4th Mar 2024
US Interest Rates - When WIll the Fed Pivot - 1st Mar 2024
S&P Stock Market Real Earnings Yield - 29th Feb 2024
US Unemployment is a Fake Statistic - 29th Feb 2024
U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - 29th Feb 2024
What a Breakdown in Silver Mining Stocks! What an Opportunity! - 29th Feb 2024
Why AI will Soon become SA - Synthetic Intelligence - The Machine Learning Megatrend - 29th Feb 2024
Keep Calm and Carry on Buying Quantum AI Tech Stocks - 19th Feb 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Stock Market Crash and Market Efficiency

Stock-Markets / Financial Crash Sep 21, 2009 - 05:07 AM GMT

By: Gerard_Jackson

Stock-Markets

The share market crashes that reverberated around the world confirmed the prejudices of many (some of whom are paid to know better) as to the irrationally of markets. There was much gleeful parroting of Keynes' misleading comments stating that share markets were nothing but casinos that graphically demonstrate the excesses of capitalism. Of course there has been a great deal said in recent years about the efficiency of markets and the cause of fluctuations. Since the 1960s the efficient-market hypothesis has held sway among a great many people. This thesis holds that markets are extremely efficient in the sense that all information about the past, the present and the future are swiftly built into share prices.


This view is derived from the model of perfect competition in which all market participants share the necessary information, resources are never misallocated, prices never distorted and adjustments are instantaneous. This is a thoroughly mechanistic and fallacious way of looking at the economy and explains why the theory has been unable to account for, let alone explain, market crashes.

In brief, the market-efficiency theory asserts that stock markets are perfect. If these markets had attained the degree of perfection that advocates of the market-efficiency theory claim for them then they would cease to be markets. It is little realised, even among a large number of economic commentators, that markets exist because certainty does not. It is because we live in an uncertain world in which the future is always unknown (though we can usually form sound expectations of what it will be like, at least in the short run ), where knowledge is ephemeral, subjective, widely dispersed and continuously changing and where expectations are always clashing and plans failing that the market comes into existence as a spontaneous coordinating process.

Two conclusions can be immediately drawn from the market-efficiency theory: (a) it is impossible for people to consistently make profits on the market; (b) a less obvious conclusion is that prices are never falsified or distorted and thus cannot contain misleading information. As for the first conclusion, a small minority of investment advisors like Peter Lynch and Warren Buffet, for example, have out-performed the market over a long period. The second conclusion founders on the little known but vital fact that credit expansion distorts prices and creates malinvestments.

By expanding bank credit we distort investment decision-making, we also create surplus 'investment funds' that generate speculative frenzies. Shares (which are really titles to land and capital goods) become overpriced as speculators inflate their values. But this goes in tandem with a credit boom that also inflates company profits and hence generates expectations of increasing income streams which are then embodied in share prices. When central banks eventually take steps to curb the excesses the speculative bubble collapses.

That this process seems to happen on a regular basis has given rise to the business cycle myth. That economic history in the form of boom-and-bust 'cycles' seems to repeat itself with painful regularity demonstrates that people never learn from their economic mistakes. The origins of this theory go back to David Ricardo and the currency school. The 'Austrians' revived and greatly refined it. If it was not for the Keynesian counter-revolution in economic thinking what has become known as the Austrian theory of the trade cycle would now be the standard explanation.

Notwithstanding the theory's explanatory power, most economists, especially in Australia, insist on looking elsewhere for an explanation of market 'bubbles', speculative frenzies and depressions. They completely overlook the obvious: only sustained credit expansion can inflate share prices and fuel lengthy speculative frenzies.

The market is not a mechanical system, the workings of which can be easily mapped and its motions predicted with clockwork-like precision. It is a spontaneous institution (meaning that it was not consciously designed), an astonishing coordination process consisting of a remarkable structure of negative feedback processes. Despite its hardy nature, flexibility (if not sabotaged by unions or politicians) and inimitable coordinating capacity, its feedback processes will be distorted if fed false information. This is something efficient-market hypothesis adherents do not recognise. Unfortunately, they are not alone in their ignorance.

By Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes' economics editor.

Copyright © 2009 Gerard Jackson

Gerard Jackson Archive

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in