Wild fluctuations in asset prices show we know nothing

Investing your capital is a difficult puzzle! But a puzzle that can’t be avoided, because your capital is always invested in one investment vehicle or another, even if it’s just gold coins buried under the roses. (No, I didn’t do that. Please don’t dig up my roses.)

The greatest puzzle for me is the wild fluctuation of asset prices. This seems to show that far from being a market with perfect knowledge, it’s instead a market with hardly any knowledge. If the main players had much knowledge — about current facts, the underlying processes, or the future that will result from them — then the prices would be very stable until some unforeseen event, such as an exploding volcano, added significant new knowledge to the game.

And it does seem to be little more than a game, like high-stakes poker in a card club. Even if there were any big guys with real knowledge, they’d be using it to get superrich, not sharing it with me in the pages of the Wall Street Journal or a newsletter from a bank.

Or maybe it’s a crooked game. According to the cliché, “The best way to predict your future is to create it!”, so it’s possible that the superrich are able to manipulate the market enough that they can cause and profit from predictable fluctuations. If so, they aren’t going to tell me about that either.

But you’ve got to put your retirement money somewhere.

Poor House Bistro

According to Paul Graham

the financial reporters stuck writing stories day after day about the random fluctuations of the stock market. Day ends, market closes up or down, reporter looks for good or bad news respectively, and writes that the market was up on news of Intel’s earnings, or down on fears of instability in the Middle East. Suppose we could somehow feed these reporters false information about market closes, but give them all the other news intact. Does anyone believe they would notice the anomaly, and not simply write that stocks were up (or down) on whatever good (or bad) news there was that day? That they would say, hey, wait a minute, how can stocks be up with all this unrest in the Middle East?

Aside: According to John Cassidy

Given the nature of the policies that the Bush and Obama administrations had adopted, public anger was inevitable. By the end of 2009, almost all the big banks had repaid their TARP bailouts, but they continued to be the recipients of official largesse. With the Fed holding short-term interest rates at virtually zero, firms like Citigroup and Goldman Sachs could borrow money from one arm of the government (the Fed) or from investors (by issuing short-term commercial paper) for next to nothing and, by purchasing US bonds, lend it to another arm of government (the Treasury) at an interest rate of 3 or 4 percent. By playing “the spread,” any moderately competent Wall Street trader could generate large returns for his desk and a big bonus for himself without actually doing what banks are supposed to do: furnishing money to firms and funding capital investments. While bank profits were soaring, many businesses and individuals were still finding loans hard to come by.

The other losers in this game were those who had cash stashed in a savings account or money market mutual fund. “What we have right now is a situation where every saver in the country is, essentially, paying a huge tax to bail out the banking system,” noted Raghuram Rajan, the University of Chicago economist who, back in 2005, had issued a fateful warning about the dangers of a financial blowup. “We are all getting screwed on our money market accounts—getting 0.25 percent—and the banks are making a huge spread on nearly every asset they hold, because they are financing them at pretty close to zero rates.”

The Obama administration didn’t come out and say so, but enabling the banks to make big profits was one of its policy objectives.

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