Malkiel's Mendacity

by: Cullen Roche

As I’ve developed an understanding of the macroecon and finance world I find the same disturbing trends across both fields – a highly politicized school of thought has dominated much of the thinking.

Regular readers probably know my views on mainstream economics, but I find many of the same problems muddying the waters in finance. For instance, concepts like the Efficient Market Hypothesis and Rational Expectations are essentially conservative ideas constructed in a manner to establish an empirical argument against forms of government intervention. They essentially say “markets do things better than governments so stay out”. There’s a lot of truth to ideas like this, but they dominate the discussion to the point where they’ve become extremely counterproductive. And yet people win Nobel Prizes for these ideas and the underpinnings of Modern Finance rest largely on this kind of biased thinking (no wonder they reject behavioral finance given how biased most of these economists are!).

I was reminded of this as I read this blog post by Burton Malkiel who scolds stock pickers for their performance in 2014. For instance, Malkiel, the father of Random Walk and a proponent of the Efficient Market Hypothesis, says you shouldn’t try to predict the future returns of assets because the markets are basically too efficient to outguess them.

That is, of course, unless he feels like predicting the returns of asset classes like he did before 2014 when he told people to avoid long-term US government bonds, the very best performing asset class so far in 2014 (zero duration bonds are up an amazing 27.5% this year and 30 year bonds are up 17%+):

Governments wrestling with large budget deficits, huge unfunded liabilities for entitlement programs, and high unemployment rates have adopted policies of keeping interest rates extraordinarily low.

Ten-year U.S. Treasury bonds yielding 3% provide neither generous returns nor an adequate margin of safety to make a shift from equities to high-quality bonds an unambiguous risk-reducing strategy.

I remember the article vividly because it jumped out at me as being so obviously hypocritical and erroneous. What’s ironic here is that Malkiel is not only picking assets specifically (something his own theories say you shouldn’t try to do), but he’s making what is obviously an erroneous political argument. The US government is not at risk of some type of Grecian moment because of “unfunded liabilities”. The US government is not going bankrupt yet he paints the government’s debt situation as something dire that warrants an underweighting in the asset class.

Malkiel is basically saying he knows more than the markets do so you should listen to him and underweight US government bonds. Malkiel might not like all this government debt, but it should have NOTHING to do with his theories on finance. But he is clearly just making a political argument masquerading as financial analysis. Sadly, that’s what much of modern finance and modern economics is – just politics masquerading as science.

This is important stuff. And if I am right then the future landscape of modern finance and mainstream economics will look very different than it does today because lots of people are going to realize that the underpinnings of the current thinking aren’t just a little bit wrong, but very wrong.