Wednesday, July 18, 2007

Lawrence Kudlow

Lawrence Kudlow recently posted the following on National Review:

Markets Give Bush a Thumbs Up [Larry Kudlow]

Despite all the criticism President Bush has received over his administration’s Iraq war policies, isn’t it interesting that stock markets have been booming during the whole period from early 2003 onward?

In fact, after the president admonished congress last Thursday to toss aside troop withdrawal timetables and to give General Petraeus’ new counter insurgency plan time to work, the Dow Jones soared 300 points on Thursday and Friday reaching new record highs.

The stock market boom is part of a global phenomenon as the spread of market capitalism marches worldwide. Record wealth gains and growth are occurring in all corners of the globe. I have long believed that stock markets are the best barometer of the health and wealth of a nation. This market indicator reflects economic growth and business conditions, in addition to overall safety and security.

My strong suspicion here is that the message of the American and global stock market boom is one of support for the Iraq war and a steadfast US commitment to stop terrorism. If the U.S. doesn’t do it, no one else will.

My take here is that Mr. Bush’s steadfastness on the war late last week was well received by U.S. and global markets.

Stocks are giving the president a vote of confidence.
Among the things that I identify as wrong with this post:

1. Why anthropomorphize "stocks" and the "market"? Stock purchasers are the ones driving up prices for some reason. But if you put it that way, what reason is there to think that the average stock purchaser knows more about the effects of the Bush Iraq policy than, say, the intelligence community? (Not that the latter group is likely to make successful predictions either.)

I'm familiar with the efficient market hypothesis, which states that the market instantaneously incorporates all information about a given company into that company's stock price. The strong form of that hypothesis has always struck me as somewhat ludicrous, at least as to many individual cases. But what Kudlow seems to believe is something far stronger, something more like an efficient world hypothesis, whereby the stock market (as a whole) instantaneously reflects not just information about world events that are not directly tied to any company, but can also successfully predict the future outcome of such intractable dilemmas as Middle Eastern foreign policy.

If Kudlow has any evidence that the stock market has such magical powers, he should bring it forth.

2. Having just read Nassim Taleb's excellent books Fooled by Randomness and The Black Swan, I'm baffled that anyone thinks it possible to identify the cause for week-by-week fluctuations in the stock market. There is probably no such single cause in the first place, and even if there were, neither Kudlow nor anyone else is likely to figure it out: there are too many unidentifiable forces and randomness at work here.

* * *

So what Kudlow has done is propose a simple equation: "Rising stock market = future success for U.S. policy in Iraq." Everything about this equation is fundamentally unknowable. No one knows the cause for why the stock market rose over the past week, and there may be no "cause" at all (it could be part of the random walk of stock prices). And no one (including mere investors) can conceivably know what the future of Iraq will be over the next few years.


Blogger "Q" the Enchanter said...

And no one knows what "success" in this context even means.

9:36 PM  
Blogger Garry said...

So does this conflict with the "Wisdom of Crowds" recently touted in some recent books?

5:45 PM  
Blogger Stuart Buck said...

No. What Taleb says is that crowds are good at guessing the outcome of reasonably determinate questions, such as the number of jellybeans in a jar (after all, it's not as if a small jar is suddenly going to turn out to have ten quadrillion jellybeans, or minus 17,000 jellybeans -- the set of possible outcomes is fairly constricted). But crowds are not good at guessing the outcome of inherently chaotic and complex processes, such as the outcome of a war, the future of foreign policy, etc., where there's a much greater chance that something totally unexpected will happen.

9:14 PM  

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