Confirmation bias? By Scott Sumner

I agree with David Henderson’s new post, which starts off with this Bob Murphy quote on the recent stock market decline:

As shocking as these developments [drops in stock prices and increased volatility] may be to some analysts, those versed in the writings of economist Ludwig von Mises have been warning for years that the Federal Reserve was setting us up for another crash.

I find Murphy’s statement rather puzzling. What was “shocking” about the stock market decline? Isn’t the US stock market normally pretty volatile? Hasn’t this been a relatively non-volatile year until last week? Isn’t it normal for stocks to decline 10% or 20% every so often? I’m not being sarcastic here, I honestly don’t know what we are supposed to find “shocking” about an occasional period of stock market volatility.

Murphy seems to suggest that the fact that Austrian economists were not surprised by the volatility is a point in their favor. But why? Who was surprised? If you had asked me a year ago “Do you expect occasional volatility, up and down?” I would have said yes, and also that I had no idea when that volatility would occur, or in which direction the market would move. (Actually in periods of extreme volatility price declines are somewhat more common.)

Now perhaps Murphy is making a stronger claim, that the Austrians weren’t just unsurprised by the fact of volatility, but also the timing. That they saw it coming last week. That would be impressive. So let’s go back to August 2011, and see what Murphy had to say:

Investors the world over are still reeling from last Thursday’s massive plunge in the US equity markets, in which the major indices all gave up more than 4 percent. It was the worst day for the US stock market since December 2008. None of this should surprise those conversant with Austrian economics. The “fundamentals” of the economy have been and remain awful because the government and Federal Reserve are consistently doing the wrong things. The apparent recovery, fueled by Bernanke’s sheer money creation, has been bogus all along. Bubble, Bubble, Bubble For some reason, people still cling to the vague hope that — at least if we wait long enough — the market always goes up, and “buy and hold” is a great strategy.

This sounds pretty similar to the recent comment, but also equally vague. If Austrians want to claim they can predict markets, they’ll need to be more specific. As far as I can tell Murphy seemed to be rather pessimistic about the prospects for stocks, and the early August 2011 drop was a sort of “I told you so” for Austrian economics.

A commenter named Charlie directed me to this older Murphy post, and added this helpful information:

Since the article: S&P 500 is up 60%

Gold ETF (GLD) is down 33%

Silver ETF (SLV) is down 64%

Now in fairness to Bob, the earlier post did include this disclaimer:

Knowledge of Austrian economics doesn’t render someone an expert investor, but it certainly gives advance warning of the major trends in the economy.

But Charlie also found this warning about the economy:

In this environment, someone relying on fixed-income investments (such as private annuities or, heaven forbid, government retirement checks) could be wiped out by massive price inflation.

Austrians aren’t the only ones who think they have something useful to say about future trends in asset prices. Keynesians and others also like to talk about “bubbles”, which I take as an implied prediction that the asset will do poorly over an extended period of time. If not, what exactly does “bubble” mean? I think this is all foolish; assume the Efficient Markets Hypothesis is roughly accurate, and look for what markets are telling us about policy.

One other point. If the sharp decline early in the week told us something deep and meaningful about the wisdom of ABCT, then does the recent rebound weaken that argument, or was that rebound also consistent with the model.