Wednesday, October 20, 2010

Wonderful World Of Fallibility And Reflexivity

While the markets digest the Chinese move and latest message from Beige Book, let's look at some issues that are probably worth mentioning from the weeks of my recent absence.

George Soros was addressing "The Sovereign Debt Problem" at Columbia University on October 5. As a starter to the fundamental problems of current affairs, the reminder of his theory is worth re-reading:

... The main points to remember are, first, that rational human beings do not base their decisions on reality but on their understanding of reality and the two are never the same -although the extent of the divergence does vary from person to person and from time to time - and it is the variance that matters. This is the principle of fallibility. Second, the participants' misconceptions, as expressed in market prices, affect the so-called fundamentals which market prices are supposed to reflect. This is the principle of reflexivity. The two of them together assure that both market participants and regulators have to make their decisions in conditions of uncertainty. This is the human uncertainty principle. It implies that outcomes are unlikely to correspond to expectations and markets are unable to assure the optimum allocation of resources. These implications are in direct contradiction to the theory of rational expectations and the efficient market hypothesis.
An excerpt from the lecture is available at Financial Times.

Then, to highlight the ponziness of US economy, and to provide an explanation why corporate investment has been so weak in that country, and why any further investment is very risky, one should consider the words of Brian Sack, the head of the New York Fed' s markets group:
Nevertheless, balance sheet policy can still lower longer-term borrowing costs for many households and businesses, and it adds to household wealth by keeping asset prices higher than they otherwise would be.

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