On Tuesday, the 2nd most emailed article on WSJ.com was Crisis Compels Economists To Reach for New Paradigm.

It is an intriguing look at the problems of the the field of economics. It went, however, way too easy on both the profession and its practitioners. The article fails to ask some very basic questions about the soft science, and does not discuss the fundamental incompetency of many economists.

Given the failures of the profession — failing to anticipate the worst recession in decades, missing the warping effect of the housing boom, not recognizing the credit collapse until too late — a damning indictment of the dismal science might have been more appropriate.

Perhaps I can be of assistance.

There are many areas I would have liked to see the Economics Crisis article explore: The lack of Scientific Method, the mostly awful performance of economists, its misunderstanding of the value of modeling, the bias inherent in Wall Street variant of economics, and lastly, the corruption of economics by politics. I will just touch on some of these; you can fill in much of the blanks yourself.

Let’s start with the basics. Hard “science” — Physics, Biology, Chemistry, and all variants thereto — begins humbly. They try to describe the universe around us by creating theories, and then testing them. These theorems are always preliminary. Even when testing validates them, Science is always prepared — even eager — to replace them with newer theories that are proven to be even more valid.

The humility of science begins with an admission: We know nothing. We seek to learn through experiment and logic, and constantly evolve more and more accurate explanations. Scientific belief evolves gradually over time. Nothing is assumed, presumed, or hypothesized as true. Indeed, research is a presumption that current theories are inadequate or incomplete. The practice of science is a an ongoing search for better explanations, more proof, further verification — for Truth.

Science is the ultimate “show me” state.

Economics has a somewhat, shall we call it, less rigorous approach. Indeed, the arrogance of economics is that it is the polar opposite of Science. It begins with a few basic assumptions, many of which are obviously untrue; some are demonstrably false.

No, Mankind is not a rational, profit maximizing actor. No, markets are not perfectly, or even nearly, efficient. No, prices do not reflect the sum total of all that is known about a given market, sector or stock. Those of you who pretend otherwise are fools who deserve to have your 401ks cut in half. That is called just desserts. The problem is that your foolishness helped cut nearly everyone else’s 401ks in half. That is called criminal incompetence.

Where was I?  Ahhh, our sad tale of the practitioners of the dismal arts.

Starting from a false premise that fails to understand the most basic behaviors of the Human animal, economics proceeds to build an edifice of cards on a foundation of sand. (How could that possibly go astray?) Like a moonshot off by a few inches at launch, by the time the we reach further into time and space, the trajectory is off by millions of miles . . .

~~~

Economics has had a justifiable inferiority complex versus real sciences the past century. It has attempted to overcome this by throwing lots of smart mathematicians at its practice, in an attempt to make the social art seem more “sciency,” and thus  more credible. This had led to lots and lots of formulas and models. The problems is, Economics places way too much weight on these. It creates an illusion of precision where none exists. The belief in their models led to all manner of mischief, from subprime to derivatives to risk management.

Economics forgot George E. P. Box’s most basic rule:

“Essentially, all models are wrong, but some are useful”

Box was a statistician who recognized the fundamental truth of all attempts to depict the universe mathematically: They are inherently flawed.

He also understood that these flawed attempts can at times have value. His insights contextualize what mathematical modelers do — and fail to achieve.

Economics fails at this often.  The belief in the validity of their models — like the theories they are based upon — is the Achilles heel of the profession.

This is not to say there are not good, even great economists (some are even friends of mine!) who foresaw the coming crisis and warned about it. Many are aghast at the rigor mortis in the academic establishment; some are horrified at how poorly the profession has done. Forget forecasting the future, too many economists cannot accurately describe what happened yesterday.

The Behaviorists have been fighting the mainstream for decades now, trying to correct the errors of the basic building blocks of the dismal science.

>

Excerpt after the jump.

>

Previously:
The Mystery of the Awful Economists
RealMoney.com, 3/2/2005 3:42 PM EST

http://www.thestreet.com/p/rmoney/barryritholtz/10211333.html

(If you cannot access the Real Money piece, click here).

Mystery of the Awful Economists, part II (April 8th, 2005)

http://www.ritholtz.com/blog/2005/04/mystery-of-the-awful-economists-part-2/

Mystery of the Awful Economists part III (April 13th, 2005)

http://www.ritholtz.com/blog/2005/04/mystery-of-the-awful-economists-part-iii/

RIP Chicago School of Economics: 1976-2008 (December 23rd, 2008)

http://www.ritholtz.com/blog/2008/12/chicago-repudiation/

Why Economists Missed the Crises (January 5th, 2009)

http://www.ritholtz.com/blog/2009/01/why-economists-suck/

The Big Picture: On the Efficient Market Hypothesis (2005-09)

The Big Picture: On Prediction Markets (2004-09)

Source:
Crisis Compels Economists To Reach for New Paradigm
MARK WHITEHOUSE
WSJ, NOVEMBER 3, 2009

http://online.wsj.com/article/SB125720159912223873.html

Excerpt:

“The past century saw two revolutions in the way economists view the world. Both required painful crises to set them in motion, but both arguably improved government’s ability to manage the economy.

The first came after the Depression, when economists built some of the first mathematical models that policy makers could use to try to manage the economy. The second came after the inflationary 1970s, when economists created new models that took into account how people’s expectations, such as about prices or income, can influence the economy over time.

During the second revolution, the U.S. economy entered a period of stability and low inflation that lasted from the 1980s through most of the 2000s, leading many economists to believe they had triumphed over business cycles. As Robert Lucas of the University of Chicago, one of the intellectual fathers of the models, put it in 2003: The “central problem of depression-prevention has been solved…for many decades.”

The result was a new orthodoxy, known as “rational expectations,” that still dominates, underpinning everything from the way pension funds invest to how financial analysts put values on securities. Among its main branches is the idea that markets are “efficient,” meaning that even an uninformed investor can get a fair shake, because the price of any security tends to reflect all available information relevant to its value.”

Category: Markets, Mathematics, Really, really bad calls

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

80 Responses to “The Hubris of Economics”

  1. “The saddest aspect of life right now is that science gathers knowledge faster than society gathers wisdom.”

    - Isaac Asimov

  2. globaleyes says:

    THIS post represents BR at his best. I like how our scientific search begins WE KNOW NOTHING. That’s how every day starts for me…

  3. Casual Observer says:

    KA-BOOM!!!!
    First & foremost – great piece & great Asimov quote.
    I have for years had issues with economics (starting in college and throughout my career). This piece provides the clarity in the error of the profession and the LACK OF HUMILTY and utter arrogance that goes along with it.
    I’ve stated over a BILLION times that even though theories could be sound, the practical applications/implementations is what is flawed (see diversification asset allocation models). NOW to find out that the THEORIES are fundamentally flawed…..well you would think we all would have learned our lesson.

    Thank you for your post & the Blog itself!!!!

  4. Charles Maley says:

    It is tough to make predictions, especially about the future. – YOGI BERRA

    It seems the big things we know the least about are the very things that count the most.

    http://viewpointsofacommoditytrader.com/1078/confusing-design-and-discovery/

  5. “What the Hell is Praxeology?

    Praxeology is the study of those aspects of human action that can be grasped a priori; in other words, it is concerned with the conceptual analysis and logical implications of preference, choice, means-end schemes, and so forth.

    The basic principles of praxeology were first discovered by the Greek philosophers, who used them as a foundation for a eudaimonistic ethics. This approach was further developed by the Scholastics, who extended praxeological analysis to the foundations of economics and social science as well.

    In the late nineteenth century, the praxeological approach to economics and social science was rediscovered by Carl Menger, founder of the Austrian School. The term praxeology was first applied to this approach by the later Austrian economist Ludwig von Mises (portrait at left). Along with his students (including Friedrich Hayek and Murray Rothbard), Mises employed praxeological principles to show that much existing economic and social theory was conceptually incoherent. ..”
    http://praxeology.net/praxeo.htm
    “…employed praxeological principles to show that much existing economic and social theory was conceptually incoherent. ..”

    and this ““The past century saw two revolutions in the way economists view the world. Both required painful crises to set them in motion, but both arguably improved government’s ability to manage the economy.”

    should show that there is, at least, two Schools of Thought re: Economics.

    the latter, the one being discussed in the Post, is, rather, belonging to PoliSci–an assortment of Hogwash that does, with aid of Bernays’ insights, little more than provide cover for an ever-increasing Role, of the State, in the Economy.

    This Post, good, as far as it goes, is lopsided, at best. Thinking that all ‘Economists’ are the same doesn’t qualify as thinking, at all.

    ~~~

    BR: Precisely, that’s why I would not say “All ‘Economists’ are the same.” As noted in the latter paragraphs:

    This is not to say there are not good, even great economists (some are even friends of mine!) who foresaw the coming crisis and warned about it. Many are aghast at the rigor mortis in the academic establishment; some are horrified at how poorly the profession has done. Forget forecasting the future, too many economists cannot accurately describe what happened yesterday.

    The Behaviorists have been fighting the mainstream for decades now, trying to correct the errors of the basic building blocks of the dismal science.

  6. davver1 says:

    An entire article about how we know nothing, and yet the conclusion is that the assumptions of behavioral scientists are the new holy grail (even though they can’t agree on their own assumptions).

    Here’s a hint, human society is too complicated to grasp with any economic theory. Its just guessing, and some guesses will be right some of the time due to pure luck. I look forward to a decade or two of behavioral scientists arrogantly pontificating about were they think animal spirits are today and where the market is headed next.

    I also have no doubt that since behavioral economists are just guessing some politician will manage to find some behavioral economist who will justify his giving away $X to this or that lobby for whatever reason.

    ~~~

    BR: I don’t assume behaviorists are a holy grail — however, I appreciate that these economists recognized the fundamental flaw of traditional economic belief systems.

    Do I really need to teach y’all the difference between giving kudos and pursuing a holy grail? Is the concept of “nuance” that confusing?

  7. cvienne says:

    @BR

    “The saddest aspect of life right now is that science gathers knowledge faster than society gathers wisdom.”

    Even science itself PROVES nothing…

    Scientific process is an exercise and operation set up to prove WHAT IS NOT… The quest to know WHAT IS is unattainable…

  8. rob says:

    Economics: The science of measuring with a micrometer but cutting with a chainsaw.

  9. cvienne says:

    I should say, the “outcome” of the quest to know…

  10. Mike S says:

    Mark – why do so few traders use the pure Austrian approach?

    See Marginal Revolution for the “nothing to see here” approach to critique of this article.

    Notice this is an attempt to formalize George Soro’s Reflexivity.

  11. comet52 says:

    Most of the links you added at the end don’t work.

    ~~~

    BR: Tx! They are all working now . . .

    The last 2 are searches for those posts on the key terms.

  12. Marcus Aurelius says:

    Barry Ritholtz Says:

    “. . . the reasons the legal profession and the economics profession both suffer varying degrees of public disdain, it is because of their perceived competence.”
    ______________

    Corrected:

    The reasons the legal profession and the economics profession both suffer varying degrees of public disdain, it is because of their manifest incompetence.

  13. I have detailed the horrific performance of economists many times over the years (see “Previously,” below) but I want to make a small contrast with lawyers. If you consider the reasons the legal profession and the economics profession both suffer varying degrees of public disdain, it is because of their perceived competence.

  14. odds says:

    What they need to do is remove the Bachelor of Science for Economics and replace it with Bachelor of Arts, because it is not truly a science.

  15. Mike S,

    see davver1′s point, above..

    and, note: “I also have no doubt that since behavioral economists are just guessing some politician will manage to find some behavioral economist who will justify his giving away $X to this or that lobby for whatever reason.”

    that, to me, at least, is what is being created with this current push behind the ‘behaviorist’-School..
    as well, the Keynes-crowd has, always, been heard saying: ~”If we only had more data, our models would work..”

    they may be proffering ‘Insights’ to the Keynesian/Economagician-crowd of PoliSci-Fi practitioners, but it’s, hardly, anything new to Austrians – see, again: “Praxeology is the study of those aspects of human action that can be grasped a priori; in other words, it is concerned with the conceptual analysis and logical implications of preference, choice, means-end schemes, and so forth…”

    past that, Trading and Economic Analysis are not tightly linked/have little to do with each other..

    also, you may, as well, be asking “why do so few traders use the pure Keynesian approach?”

    any decent Trader that I’ve ever known/heard about was, almost, heterodox, in the extreme, while hewing to a short list of strict Cash/Capital Management rules..

    see BR, as ex., his “Intro for Investors” series, that he wrote a # of years ago, for TSC, is, still, some of Best on the subject..(still don’t know why it isn’t on the site..)

  16. Joe Retail says:

    Charles Maley @ 8:59
    It is tough to make predictions, especially about the future. – YOGI BERRA

    Economists can’t even make predictions about the past. I started a Masters’ in Economics in 2003, and they were still arguing whether the tech bubble was, indeed, a bubble. At that point I dropped out of the program.

    In Engineering I learned to make approximations based on available data that are “good enough for practical purposes” and then improve on them. I have found that to be a useful skill in real life.

  17. wally says:

    “…corruption of economics by politics”
    Absolutely! Is there any prominent economist today who does not espouse political policy? Who does not seem to have a dog in the fight? Some – Krugman is one good example – even cheerlead for contradictory policies. (ie: we need faster growth; we need to ring up a greater deficit by providing more stimulus).
    The biggest problem with this is that once somebody locks onto a political ideology, they immediately become tone deaf to arguments of the other side, even when those arguments may be quite valid. They become soldiers for the cause, not observers or thinkers.

  18. catman says:

    The EP Box quote certainly applies to “technical analysis” as well.

  19. zell says:

    MEH: Why not keep it simple though less precise with Heraclitus – Man is the Measure of All Things.

  20. zell,

    I hear ya, though, that may be, too much, a distillation..

    Heraclitus’ most fundamental departure from previous philosophy lies in his emphasis on human affairs. While he continues many of the physical and cosmological theories of his predecessors, he shifts his focus from the cosmic to the human realm. We might well think of him as the first humanist, were it not for the fact that he does not seem to like humanity very well. From the outset he makes it clear that most people are too stupid to understand his theory. He may be most concerned with the human relevance of philosophic theories, but he is an elitist like Plato, who thinks that only select readers are capable of benefitting from his teachings. And perhaps for this reason he, like Plato, does not teach his philosophical principles directly, but couches them in a literary form that distances the author from the reader. In any case he seems to regard himself not as the author of a philosophy so much as the spokesman for an independent truth:

    Having harkened not to me but to the Word (Logos) it is wise to agree that all things are one. (B50)
    Heraclitus stresses that the message is not his own invention, but a timeless truth available to any who attend to the way the world itself is. “Although this Word is common,” he warns, “the many live as if they had a private understanding” (B2). The Word (account, message) exists apart from Heraclitus’ teaching, but he tries to convey that message to his audience.

    The blindness of humans is one of Heraclitus’ main themes. He announces it at the beginning of his book:

    Of this Word’s being forever do men prove to be uncomprehending, both before they hear and once they have heard it. For although all things happen according to this Word, they are like the unexperienced experiencing words and deeds such as I explain when I distinguish each thing according to its nature and show how it is. Other men are unaware of what they do when they are awake just as they are forgetful of what they do when they are asleep. (B1)..”
    http://plato.stanford.edu/entries/heraclitus/
    http://clusty.com/search?input-form=clusty-simple&v%3Asources=webplus&query=Heraclitus

    wally,
    w.this: “They become soldiers for the cause, not observers or thinkers.” No doubt, many a “True Believer” to be found among the warrens of the PoliSci-Fi crowd..
    http://www.thefreedictionary.com/warren

  21. odds says:

    Barry, your elevation of science to some lofty plateau may be a little too utopian. Because if you think science is the “honest” profession where politics have been removed, try having a conversation about climate change.

    ~~~

    BR: Separate Science from the scientist

  22. [...] Barry Ritholtz at The Big Picture: On Tuesday, the 2nd most emailed article on WSJ.com was Crisis Compels Economists To Reach for New Paradigm. [...]

  23. bsneath says:

    1) and lastly, the corruption of economics by politics.
    2) Economics forgot George E. P. Box’s most basic rule: “Essentially, all models are wrong, but some are useful

    Both concepts apply to the global warming debate as well. Global warming may or may not be a man made event. However the politicization of the scientific research and almost total reliance on modeling should make one extremely skeptical of the conclusions to date.

    Regarding 1) and economics, I view Krugman to be clearly politicized.

  24. clawback says:

    BR is spot on if he’s only talking about “mainstream” economists of the past 40 years or so (which is fair enough), but let’ s not lump together all economists.

    Here’s what Mises had to say about the scientific foundations of economics and the fallacy inherent in most versions of logical positivism:

    “The essence of logical positivism is to deny the cognitive value of a priori knowledge by pointing out that all a priori propositions are merely analytic. They do not provide new information, but are merely verbal or tautological, asserting what has already been implied in the definitions and premises. Only experience can lead to synthetic propositions. There is an obvious objection against this doctrine, viz., that this proposition that there are no synthetic a priori propositions is in itself a—as the present writer thinks, false—synthetic a priori proposition, for it can manifestly not be established by experience.”

    In a nutshell, we have to begin with a priori assumptions — assumptions that can’t be gotten from experience or observation. But even still, economists of the Austrian school “test” their theories all the time. For economics, empirical testing boils down to seeing how well a theory of, say, the business cycle, conforms with known reality (in this case, history). And even Austrian economists, who are always keen to make the same sorts of criticisms BR makes here, “test” and adjust their theories over time. Austrian Business Cycle Theory is not the same today as it was in 1950 — new adjustment have been made in light of empirical evidence.

    In fact, there’s a discussion going on right now over at The Austrian Economists blog about ABCT, the recent housing bubble, and whether economics is a “science”. http://austrianeconomists.typepad.com/weblog/2009/11/the-battle-of-the-toms.html

  25. hue says:

    OT, humility for the retail investors http://bit.ly/1mO1Y5 small gains for more pain?

    Investment advice from Henry Blodgett (including some Internet stock picks?): “And, next time, don’t believe those folks who tell you ‘buy and hold is dead’!” yes buy and hold is back, as long as you did it in March.

  26. beaufou says:

    I think you have it right when you talk about models.
    Models are a form of ridiculous certainty.

    I do disagree with the politics corrupting economics though, it seems to me that economics people are very busy corrupting politics.

  27. GetALife says:

    Barry Ritholtz Says: I have detailed the horrific performance of economists many times over the years (see “Previously,” below) but I want to make a small contrast with lawyers. If you consider the reasons the legal profession and the economics profession both suffer varying degrees of public disdain, it is because of their perceived competence.

    Well, with all due respect to all professionals, it seems to me that folks dislike the legal profession since many lawyers are paid liars – they will say anything to spin things for their clients, whether those clients are rapists, murders, corporate thieves, etc. Ralph Warner and Ralph Nader pointed this out decades ago.

    Also, can you explain why this comment moderation warning keeps popping up? I had the impression that this blog didn’t censor comments/dissenting viewpoints.

  28. ironman says:

    Just because it’s closely related to the issue of what is and what isn’t science, here’s a guide to how to detect junk science.

    [BR, your inner physicist is really showing today!]

  29. HarryWanger says:

    Wow, all this euphoria allowed me to add to DXD this morning. I believe that’s a wonderful way to start this day!

  30. HarryWanger says:

    Great post BR! One morning we’ll wake up and realize that “this time is different”. Too much dependency on “this is what happened during this crisis/depression/recession.” To compare any time frame of economic despair whether it be in this country or between countries and draw any conclusions is absurd. Yet, that’s all we hear daily.

    The only thing that remains somewhat constant is human behaviour. From that we can make some assumptions but nothing more than that.

  31. hue says:

    if Pythagoras were to postulate that the earth must be a sphere today, he would be derided with websites debunking the Pythagorean theorem, thereby calling round earth theory junk science.

  32. The Curmudgeon says:

    Someone needs to defend the premises of neo-classical economics, if only just for fun:

    1) That man is a rational animal that acts in his own best interests–the primary interest being survival. Of course, this must, at some level, be true, else man would quickly cease to exist. This observation could be applied to any living being. It must, absolutely, be true, else none would exist. Think of a bear. If it didn’t seek food when it was hungry, it would soon die. If all bears behaved similarly, all bears would soon die out. This acting in one’s best interest is also the foundational principle of evolution by natural selection. The difference with man and the beasts is that man, alone, has the capacity to consciously decide to not survive. Suicide is the great paradox of humanity. Animals don’t commit suicide, but man occasionally does. So man is capable of acting against his own survival instinct, but not often does. The real problem with the theory, however, is one of perception. What does man perceive is in his best interest? One person’s perceived irrationality is another person’s leveraged bet against the odds.

    2) That markets are efficient, and all the relevant information is priced into markets. Of course, this is generally true, but the qualifier is that all relevant information must be available and actionable by all market participants. And there is no market with this sort of “perfect information”, so there is never really an efficient market. Some are less efficient than others, particularly those where information is cornered for the benefit of the few against the many, such as Goldman’s front-running computer algorithms.

    Regarding drawing clear distinctions between the “hard” and “soft” sciences: The easy sciences are the ones we generally think of as hard. To some extent, chemistry, e.g., is just elaborate cake-baking. We know most of the cause and effect relationships between the constituents of the elements such that their manipulations are readily predictable. But the soft sciences have multi-factored variables that don’t allow us to easily tease out cause and effect relationships. It is very hard in the real world to “hold all other things constant” when testing an economic model or policy. Thus, as the famed Harvard biologist Edward O Wilson has observed, the really hard sciences are sociology, economics, etc.

    All that said, the thing that struck me when I read the article yesterday in the WSJ is that by far the largest failing of the economics discipline is that it seems to believe economies can be understood by dint of scientific reductionism. The method works, but only in limited circumstances. E.g., if you wish to get more cars sold, give everyone that buys one an extra $4,500 to do so. This results in more cars being sold during the time in which it is offered–duh–but extends no further than that regarding the bigger economic picture.

  33. Dan Duncan says:

    I love this post.

    Hey Barry, how about following up with some insights about Head and Shoulder tops…or any number of other Technical Analysis insights…that you treat with undeserved deference?

    Bullish divergences…Moving Average crossovers…the ever-malleable-useless-after-the-fact- Trendline…Pivot Points….Fibonacci retracements….Are you kidding me?

    When has anyone ever run a test on the efficacy of Buying when there’s a bullish divergence? Can such a test even be performed? Talk about non-falsifiable nonsense!

    Here’s an unsubstantiated assertion, replete with a Holy Fibonacci Number: 61.8% of Technical Analysis Pseudo-Science has never been tested. 100% of it is a joke, designed to convince Traders that markets are not efficient, and that the Trader can pocket inefficiencies by employing MACD.

    And we’re getting a post on hubris….

    Has any “discipline” which purports to involve analysis ever been less-analyzed than Technical Analysis?

    Barry Ritholtz, proponent of Technical Analysis…lecturing on the Scientific Method.

    C’mon.

  34. Lugnut says:

    The problem with mathematical models is that rely upon stated assumptions, and expected behaviors in order to reduce the number of co-variables that can throw a wrench into expected outcomes. One of those is market integrity, such that trades and behaviors occur within the intended guidelines of the legal and regulatory frameworks.

    We obviously know at this point that those are merely window dressing, so when a statisically significant number of the larger players within a market operate at the fuzzy edges of those assumptions, the only models that can hope to capture an accurate snapshot of events within their model have to incorporate chaos theory into their equation sets. Such a significant portion of the Beta we have experienced is a direct result of operations that occured “out of bounds”, that no normal market analysis model could hope to incorporate it.

    Going forward though, one would expect the smarter economists to build models of market beta with presumed expectations of regulatory capture, non-existent rules enforcement, crony based fiscal policy formation, paid for legislation and corrupt governance.

  35. HarryWanger says:

    Dan: I’m with you on the technical analysis bullshit. I laugh when each day the same chartist will tell us why the market will go up based upon 15 minute bars on the 9-day moving average but changes it when it doesn’t fit to the weekly 120 day moving average that supports his/her analysis. It’s total bullshit.

    But…there is a psychology involved. Humans always look for trends and will find something in anything if they look hard enough with a conviction already in mind. That being said, certain TA (volume and velocity) can be useful since a vast majority of people use them. Thus the psychological element comes into play.

    I recall hearing several traders a few years back discussing, with varying opinions, where the market was heading. They were overwhelmingly bullish and were confused when the market went down. I remember one of them saying, “If we’re trading and we all are bullish, then how could the market possibly go down?” They confused their small sample with the overall psychology of the market.

    Think about it – is it really possible for hundreds of millions of shares to be traded and realistically hold a composite support level? No way. But when thousands are convinced of the importance of that “support”, when it goes through or “bounces” they buy or sell. The prophesy is fulfilled only due to the human nature of the traders, nothing more.

  36. Transor Z says:

    This acting in one’s best interest is also the foundational principle of evolution by natural selection.

    TC, I think in this discussion it’s important to distinguish between conscious (“mindful”) rationality and automatic behavior. There’s inherent “intelligence” in the human organism that combines the automatic and the mindful. Redundant sensory organs, CNS and a protective endoskeleton are very useful adaptations. Unprotected male genitalia in a bipedal setup, not so much.

    Q: How much of product marketing campaigns and salesperson techniques are designed to appeal to “rational”/mindful faculties and how much to automatic (e.g. sexual arousal) processes? Sex sells and if it bleeds it leads.

    It’s why mortgage disclosures show consumers side-by-side comparisons between the exotic loan product being offered to the consumer and what a standard 30-year fixed payment schedule would look like.

    Oh wait… they don’t right now? Oh. :-)

  37. Andy T says:

    The problem with the Economics profession is that most were brain-washed into believing the Chicago neo-classical school of monetary theory. It’s what gets taught in business programs and econ. schools in fine institutions all around this country. And, it has proven to be a failed theory in reality.

    Please research Steve Keen’s work to better understand an alternative explanation for money creation and destruction.

  38. callistenes says:

    Barry,
    Funny everything you said is also true of psychology. When scientists tried to validate all of Fraud’s work they found that basically none of it could be proven and most was disproved. Especially in regards to child psychology. How anyone could take a victorian era mans theory about children to heart is beyond sillyness. Considering he had none of his own and if he did they would have been cared for by a wife and/or nanny.
    I say all this cause I know you believe in the psychology of markets and the players.

  39. clawback says:

    Yep, Steve Keen’s work is extraordinary. Like Minsky, he doesn’t believe that “rational” means “always getting it right.”

  40. torrie-amos says:

    I’m in the behaviorist field, the most fascinating thing is the more you know the less you tend to think about basic principles. Face it, most economist don’t like to deal with 6th grade math which is what it is all based upon. 98% of behaviroists I know have no idea why they themselves behave a certain way, the basic tenant is trust, which happens do be fungilbe under xyz conditions………you layer upon that the recency effect, the most recent thing is the most emotional and man we are on our way, those are really all you need to know to do 97% of stuff

  41. MRegan says:

    @Lugnut

    I like this notion of yours: “Going forward though, one would expect the smarter economists to build models of market beta with presumed expectations of regulatory capture, non-existent rules enforcement, crony based fiscal policy formation, paid for legislation and corrupt governance.”

    I believe that observing the actions (tip o’ le chapeau a MEH) of certain players is important. With friends and family I discussed comments made by Mark Mobius in a July interview with Bloomberg about Mother Russia and it became apparent that Mechel OAO (MTL) would go on a tear. It traced from the mid 9s to 21+ in short order. No technical analysis needed. Economics should be scrapped in favor of spying on the rich and powerful.

  42. flipspiceland says:

    “You know you are on the road to success if you would do your job, and not be paid for it.”

    @Big Picture: This is what the Abolitionists fought a war over.

  43. beaufou says:

    flipspiceland
    I was just thinking that Barry was being a little bit sarcastic with that quote.

  44. Bokolis says:

    I’ve always considered it an art, which is why I didn’t bother with the egghead math necessary for a BS and beyond. Egghead math is a powerful tool, but it is practically (practically) useless when nobody (else) knows how to effectively apply it.

    Their failure at their work points more towards their failings as people than their competency. Whether jocks, sanitation workers or economists, people that are that good (or have worked so hard) at one thing usually suck at everything else.

    Whether married to, or shilling for, their preferred “school,” to the exclusion of the others, it’s just another one of those failings.

    As the title of this blog would indicate, the readers know that BR is a well-rounded guy (pun was unintentional). What’s lost on those who either didn’t see this coming or lacked the conviction to take a stand is, as Carlito explained, if you can’t see the angles no more, you’re finished.

  45. [...] However, in the spirit of being somewhat optimistic, I’d like to point you toward this commentary by Barry Ritholtz on what he sees as the issues facing economics. On Tuesday, the 2nd most emailed [...]

  46. The Curmudgeon says:

    @TZ

    “TC, I think in this discussion it’s important to distinguish between conscious (”mindful”) rationality and automatic behavior.”

    The dichotomy between what we suppose to be instinctual behavior and self-directed behavior is one that has, to put lightly, been in great dispute throughout centuries of philosophical dispute. In my view, man is the only animal truly capable of free will, else there wouldn’t be suicide.

    However, it is not the sentient conscious man to whom advertisers direct their communications. It is to the base emotion and instinct, I think because, as you say, sex sells, and so does food (always more of each, please) and distinction/honor, such as can be found in driving the coolest car down the highway. Distinction/honor is a base survival instinct in herd animals, which in some respects, we’ve become.

  47. RichmondTom says:

    As I recall from my physics class, we started by assuming a lead ball and a feather dropped in a perfect vacuum then later considered the added complexity of an atmosphere. When we discussed planetary motion, we began by assuming a point mass for each body. Is it so unreasonable to assume that man is at the core a rational being with added complexities? If I offer a choice to a random person of either a half pie for a dollar or a full pie for the same price, would you have NO idea which one he or she would choose? Likewise, shouldn’t the debate about financial markets concern their degree of efficiency rather than “efficient” or “not efficient”? Prices obviously reflect available information to some extent – we might argue about how much and how quickly – but for the most part they are driven by economic facts (and usually in the right direction).

  48. Lugnut says:

    @MRegan

    Rodney had it right on Economists. Stanford won’t teach you how the real world operates

    http://www.youtube.com/watch?v=YlVDGmjz7eM

    If ever there was a good thread to post this clip, this is it.

  49. advocatusdiaboli says:

    Excellent essay BR and an example of why I read your blog every day. My personal addition is that while the goal of both economics and general science is to attempt to fill a vacuum in human understanding and knowledge of the world about us, only general science delivers towards that goal with provable improvement. Economics instead delivers an illusion of control and understanding that provides a both a mantle and camouflage for those who wish to deceive, manipulate, and cheat others for their own gain but also a dangerous illusion that leads a majority of people astray in their attempt to understand their world and its affect on them.

  50. [...] Barry Ritholtz, “The belief in the validity of their models — like the theories they are based upon — is the Achilles heel of the profession.”  (Big Picture) [...]

  51. ashpelham2 says:

    This topic reminds me of why I majored in Accounting, and not Finance or Economics: with Accounting, you are reporting transactions, or things that have already happened. There is no predicting. No journal entry is required unless a transaction has completely or partially happened, as in the case of accruals. I can PREDICT what my depreciation expense will be next year, because I’ve already committed to purchasing or constructing assets that can be depreciated. I’m not predicting what the effects will be; I know what they will be.

    With Economics, though I enjoy the philosophy behind it, the theories are built, seems to me, on things that are expected. But the future is full of expectations that will not come true. Furthermore, we can’t depend on expected reactions to those things that might happen.

    I’m saying a lot here to say we simply cannot predict the future. Usually, it’s no big deal. If it rains Saturday and I have to wear my coat to the Alabama-LSU game, big whoop. But if I borrow too much money, and then unpredictably lose my job, there is a line of dominos that will fall as well.

  52. sailorman says:

    Scientific methodology moves through the following: correlation > causality > theory > proof > publication.

    Economics moves directly from correlation to publication.

  53. David Merkel says:

    One more thing to mention — the Fed influences/funds a huge amount of the macroeconomic research that goes on, which tends to make the whole profession very conformist toward their views. Another reason to shrink the Fed.

    By the way, Barry, were you invited to the Treasury confab? I know you were traveling in Dallas, but it would have been nice to have you there.

    http://alephblog.com/2009/11/04/my-visit-to-the-us-treasury-part-2/

    David

  54. HarryWanger says:

    BR: Check out your feeds today!

    ~~~

    BR: I noticed that before this post went up . . .

  55. bergsten says:

    Douglas Adams wrote something to the effect that “if anyone manages to figure out the meaning of the universe, the universe instantly changes to something else.”

    Economics is one of the few disciplines whose true purpose is to predict the future in order to stick it to the other guy (Politics being another).

    The corollary is that, once an economic theory is accepted. everybody else does their damnedest to subvert it to their own ends (in order to stick it to the other guy).

    So, just like Adam’s cynical (but probably accurate) theory, economics, BY DEFINITION, cannot predict the future, because it’s in everybody else’s interest for it to fail (which is why most Economists get paid up front).

    Quod Est Demonstradum, MEH.

    Anything else anybody would like to discuss?

  56. The Curmudgeon says:

    @AshPelham:

    Roll Tide! (B.S. in Economics, 1985)

    I don’t go to the games though. I’m a curmudgeon. I don’t like people. Especially not crowds of ‘em:)

  57. bergsten,

    this: quod erat demonstradum – which was to be proved or demonstrated

    http://volga.eng.yale.edu/sohrab/personal/latinwords/

    is nice, and all, though, being dense, I’m not understanding it, in context..

  58. MRegan says:

    Lugnut-

    loved the clip-funny- thanks

    Looks like Rodney’s warning about Fantasyland was spot-on! The costs of construction were poorly calculated and incomplete.

    OT-

    to all. Dynasty Metals and Mining.

    http://www.google.com/finance?q=TSE:DMM

    http://incakolanews.blogspot.com/2009/11/ecuador-todays-signing-of-new-mining.html

    Merits one’s time.

  59. CNBC Sucks says:

    Ritholtz, I am amused by your constant haranguing of the field of economics when, for Pete’s sake, Mister, you publish a blog on economics!

    You wrote: “Economics fails at this often. The belief in the validity of their models — like the theories they are based upon — is the Achilles heel of the profession.”

    I say, humanity fails at a lot of things often. The basic history of mankind can be summed up as our concerted and never-ending flirtation with our own self-destruction. I don’t think economics is any more or any less a failed human endeavor than, say, democracy, the capitalist system, or child-rearing.

    These days, I try to not trouble my mind with your haughty, esoteric intellectual debates, Ritholtz, but rather take joy in whatever macabre amusement can be extraced from a golden, daily pictorial record of the decay of our republic, long ago full of self-restraint, self-pride, and self-respect: http://www.peopleofwalmart.com/

  60. CNBC S,

    if you need a ‘Soundtrack’ for that ‘tude, try http://www.elyrics.net/read/p/police-lyrics/when-the-world-is-running-down,-you-make-the-best-of-what_s-sti-lyrics.html

    btw, what’s with the “U&I don’t see eye-to-eye”-gag ? ( ;

  61. bergsten says:

    @MEH 1:33pm — no worries, it was kind of a joke, intended to imbue the comment with a simulation of academic rigor. Or perhaps rigor mortis.

    Your initials at the end were intended as an overly subtle tribute to your vast wealth of knowledge.

  62. bergsten says:

    @CNBCS 1:46 — the major difference between http://www.peopleofwalmart.com/ and the vast majority of humanity since, well since there WAS humanity, is that now we can take pictures of them.

  63. DeDude says:

    The problem with economic theory is when it tries to create an all encompassing framework applicable to every and all situations. All models are build on certain assumptions and when those assumptions are no longer valid, then the model fails. However, just because a model fails, doesn’t mean that it is then forever wrong on everything. It is just that its creators need to learn a little humility and understand where the weak spots of their model are to be found. A classic example is the “tax-cuts create growth” model. As any other deficit spending, cutting income taxes create growth by increasing consumption in most cases, except in a severe ressesion when consumers/businesses have a hard time getting credit and are afraid they may lose their income; then a taxcut is just transfer of debt from consumers/businesses to government.

    It is indisputable that growth in a consumer driven economy is dependent on sustainable increase in real income of the consumer class. So it should have been obvious to all econimists that we were heading for a train wreck from about 2002 when increses in consumption was driven by equity withdrawal from assets that were in a bouble, rather than from increases in income. Why did so few of them raise a red flag? Was it ideology, politics or did they realy use models so flawed they were unable to see this simple problem.

  64. willid3 says:

    and to top it off
    http://www.businessweek.com/bwdaily/dnflash/content/nov2009/db2009113_669822.htm

    we can even get good information regarding what it happening. even though its available in other ways
    how can some thing be a science if you can’t measure it? or experiment to to test a theory?

  65. CNBC Sucks says:

    @ Mark E. Hoffer, who wrote: “btw, what’s with the “U&I don’t see eye-to-eye”-gag ? ( ;”

    Hoffer, don’t you know by now that we Ritholtz commenters are — whether we like it or not — in the entertainment business? There are thousands and thousands of page views reading our daily comments, and there are silent fans anxiously awaiting the utterances of both Mark E. Hoffer and The Great CNBC Sucks. Unfortunately, NONE of them are women, but my point is that it does not hurt to feign a little contention now and again to spice up the message board. Don’t you watch wrestling, or the more trendy UFC stuff? Actually, I think those UFC people actually mean business. In any case, and speaking of wresting, kudos on quite the smackdown on that poor JP Koning!

  66. bergsten says:

    Chief Tomahawk’s comment has a time of 6:09pm and it’s 3:14pm in NY. How’d that happen?

  67. Transor Z says:

    @CNBC Sucks:

    Well said. Like the man says, “Tapping out is for bitches.”

  68. bergsten,

    I appreciate this “tribute to your vast wealth of knowledge.”, but, one might do well to give credit to http://clusty.com/ and a little Spirit of Inquiry..

    the i-net is an amazing Resource, more of us should use it–while it’s still as *Free as it is..
    ~~
    CNBC S,

    Yes, Theatre, where would we be w/o it?

    Though, I’m not sure I understand, while not denying, the whole “lurker”-thing..

    past that, re: JP K smackdown, it, really, wasn’t the Goal. Some things smack of Sophistry, and I thought that was one of them..

  69. bergsten says:

    @MEH 4pm — Many years ago my technical sidekick threw together this page for searching the web:
    http://www.thebergstens.com/search.htm — I’ll add Clusty (or try to incentize Wilt to update it). You (and all others) are of course welcome to access it if it’s of help…

  70. [...] Barry Ritholtz has an excellent criticism of the article, pointing out: [...]

  71. Marcus Aurelius says:

    Damn. Dow just fell off a cliff. What happened?

  72. Chief Tomahawk says:

    Off topic, but speaking of hubris… Comcast has hired Ben Stein to pitch their products, and on the mailing which arrived yesterday, Ben Stein is labeled with “The Smartest”, fyi. I guess Comcast ignored Stein’s recent financial stock picking….

  73. Andrew Krone says:

    First, this article reads like a rant…

    I read the article and thought, “Yep, that’s about right” and then browsed the comments. Dan Duncan is very accurate here. It’s like the pot calling the kettle black.; Going after the whole profession is too broad, there should be more emphasis put on the actual people. Reaming 10 Economists would be more helpful but would require more concrete examples and a longer article.

  74. impermanence says:

    Just as some Greek guy coined the word “politics” to camouflage enslavement, another really brilliant guy else came up with the word, “economics,” to obscure the process of stealing your labor-value.

  75. van schaik says:

    All this bashing of economists took me back to The Big Picture of September 7, 2007 and a discussion of a Wall Street Journal poll. The graphics didn’t copy but for the record 11% thought we were already in a recession which left only 38% actually correct according to the NBER. This, of course, only gives us a clue on how clueless the WSJ readers tend to be. The expert economists seem to be unable to even beat the Journal readers at divining our economic future. Since I’m not an economist, but still plenty arrogant, and my website can’t even make it to your Peanut Gallery, which hurts in a strangely perverse sort of way, I’ve included my response for the hell of it.

    Recession Forecast?
    Friday, September 07, 2007 | 10:00 AM
    in Economy | Psychology/Sentiment
    Interesting WSJ Readers Poll: Will the U.S. economy enter a recession in the next six months?

    Slightly more than half (51%) do not think we are heading to a recession. About half expect a recession, or say we are already in one (38+11%).
    Note this WSJ reader’s Poll was taken yesterday (9/6/07), prior to today’s NFP data
    Friday, September 07, 2007 | 10:00 AM | Permalink | Comments (59) | TrackBack (0)

    We are still calling for a recession of a minimum of two years. We’ve lived the high life too long without a true day of reckoning. The time has come. We can blame $100 oil, federal deficits, or the moon. It doesn’t matter. The recession became an eventual fact two years ago- for details see our April 2007 post at http://jpetervanschaik.googlepages.com
    We will remain bearish until the S&P 500 bottoms below 600.
    Posted by: J. Peter Van Schaik | Jan 12, 2008 1:44:32 AM

  76. [...] Ritholtz has an excellent criticism of the article, pointing out: There are many areas I would have liked to see the [journal's] article explore: The lack of [...]

  77. waltclay says:

    http://econospeak.blogspot.com/2009/05/economics-was-ok-it-was-only-economists.html
    Peter Dorman:

    First, economic theory, taken as a whole, is culpable. The core problem is that each theoretical departure, whether it is a knotty agency problem or a behavioral kink, is inserted into an otherwise pristine general equilibrium framework. The only way you can get an article published in a mainstream economics journal (and therefore reproduce the conditions of your existence as an academic economist) is to present your departure piecemeal, showing that it exerts its effects even in an otherwise pristine universe. According to the standards that rule the profession, a GE model with one twist is theory’s version of the controlled experiment. This is why the picture Eichengreen paints for us, in which multiple unorthodox insights come together and interact synergistically, is never seen in a peer-reviewed economics journal. As a result, even though every organ of 1960′s-era orthodoxy is mortally wounded, the entire body strides vigorously forward. That is a prime reason why, despite the labors of so many clever and right-thinking economic theorists, we are in this mess.

    Second, the shift toward empiricism is not an unalloyed gain. Yes, much of this work is refreshingly open-minded, allowing the data to lead. An honest tally of the published literature, however, particularly in the top journals, will show that a majority of quantitative articles are concerned to calibrate existing theoretical models. Unless a model is so out of step or inflexible that it cannot be calibrated at all, it passes the empiricist’s “test”. Economics, as I have argued before here and elsewhere, has no culture of what in real sciences is known as a critical test, a confrontation with data that can be survived only if the hypothesis in question is highly likely to be correct. In other words, empirical work in economics, whatever sophisticated estimators it employs and stringent p-values it seeks, has little to do with the minimization of Type I error, properly understood. For this reason, bad theory (like the mind-numbing onslaught of DSGE models in macro) prosper even in the midst of the “empirical turn”. With enough tweaking, I can calibrate an equilibrium model of the US economy as of 2006, and again as of 2009. It won’t be exactly the same model, but it will use a standard set of baseline assumptions, so who cares?

  78. [...] provides an interesting look into the flaws of economics as a profession.  His post is named, “Hubris of Economics.” Economics has had a justifiable inferiority complex versus real sciences the past century. It has [...]

  79. [...] the self-help movement, we first admit what we don’t know and build from there. That becomes part of the scientific method, which a few of us want to [...]