From Paul Krugman’s extended article in Sunday’s New York Times Magazine:
In the 1930s, financial markets, for obvious reasons, didn’t get much respect. Keynes compared them to “those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those that he thinks likeliest to catch the fancy of the other competitors.”
And Keynes considered it a very bad idea to let such markets, in which speculators spent their time chasing one another’s tails, dictate important business decisions: “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.”
By 1970 or so, however, the study of financial markets seemed to have been taken over by Voltaire’s Dr. Pangloss [link is Spot’s], who insisted that we live in the best of all possible worlds. Discussion of investor irrationality, of bubbles, of destructive speculation had virtually disappeared from academic discourse. The field was dominated by the “efficient-market hypothesis,” promulgated by Eugene Fama of the University of Chicago, which claims that financial markets price assets precisely at their intrinsic worth given all publicly available information. (The price of a company’s stock, for example, always accurately reflects the company’s value given the information available on the company’s earnings, its business prospects and so on.) And by the 1980s, finance economists, notably Michael Jensen of the Harvard Business School, were arguing that because financial markets always get prices right, the best thing corporate chieftains can do, not just for themselves but for the sake of the economy, is to maximize their stock prices. In other words, finance economists believed that we should put the capital development of the nation in the hands of what Keynes had called a “casino.” [italics are Spot’s]
And that’s what we did. We’ve lived a life of magical thinking, a life where Harry Potter and Hobbits found a natural home, where God keeps making oil, and Santa will leave enough of it under the tree for another year. And real estate prices continue to climb, because everyone is so rational.
But we can’t talk about it, see? Because that would be, like, socialist, and so interfering with the market. Relax, let the Invisible Hand take care of it.
Spot thinks we’re going to have to dust off some of the dirty words to unbridled capitalism – like planning and public interest – and give the economic Alfred E. Neumans – the Chicago school of economics, David Strom, Captain Fishsticks – a time out before we piss it all away.