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The Marketplace Is Perfect: It Is Information That Is Imperfect

It is not the functioning of the economy that creates adverse outcomes; rather it is poor or inadequate information and lack of understanding that causes you to make ill-advised and costly decisions.

If you manage to collect and decipher better information than is commonly available, there is a greater chance that the Econosphere can work better for you. It's not so much that you need to discover unique facts, but rather that if you can take the same information that others have in front of them and understand it all at a much higher level, discarding the noise and making better use of your understanding of the natural laws of the Econosphere, you can thrive.

Even among professional economists, quite a few cannot sort through the day's headlines and filter for themselves those events that are relevant to the economy from those that are a distraction, and then make the decisions that benefit their lives and the lives of their loved ones. If you don't understand the Econosphere, there is a likelihood you will lurch from headline to headline, grabbing hold with both hands every upturn and downturn in the news cycle. You will greet every statement with apprehension and will have little basis to judge the quality of every promise.

For instance, consider our recent economic problems, the roots of which took hold with the burst of speculative investing in housing starting in 2004. (The roots go deeper than that, specifically to the earlier-mentioned incentives created by public policy, but those are aside from the point I want to make here.)

Is there anything wrong with a house per se? No, houses are good things. So, what was the problem? Investors (both homebuyers and major institutions that secured or invested in the underlying mortgages) over-estimated future house price gains. Lenders under-estimated the risk in lending to households for the purpose of purchasing over-valued homes. Builders built too many homes, expecting demand to remain elevated. The problem was not that the market readily allows for the construction and purchase of homes. Rather, we had an information problem. Investors ignored housing affordability as an indicator for home values; builders lost track of basic demographic certainties; banks forgot the number one rule of banking—never lend to someone who really needs the money!

So, we ended up with a mess that spread well beyond housing to every facet of the global economy. And how do we get out of a mess like this? Investors that made poor investments need to accept their losses. Banks need to foreclose upon bad loans. Builders need to stop building houses.

What about all the emergency actions that were undertaken? Ultimately, the astounding array of new policies did not stop any of the inevitable pain, but did cost U.S. taxpayers billions while likely prolonging and spreading our problems. We can see now that by intermittently and unpredictably changing the rules of the game for businesses and households so that information became even more muddled, these measures likely increased the risks inherent in our decision making.

Would it have been worse had these new policies not been put in place? No one can say with any certainty because the Econosphere does not allow for do-overs. However, given that the mess only got worse even after the measures were put into place, we must conclude that the goals of the policies were not fulfilled. And this is not terribly surprising because none of these policies were done with any reverence to the natural functioning of the Econosphere. No matter how well intentioned they were, they never actually had a chance.

Along these same lines, we cannot help but wonder what if housing speculators and mortgage lenders (not to mention the FDIC, Federal Reserve, Congress, and whoever else might also act as an anointed public overseer) had better information before any of this had begun, it all could have been avoided. Better knowledge of and respect for the powerful natural laws of the Econosphere would have saved us a lot of time and headaches! We cannot improve the Econosphere anymore than we can improve upon the laws of physics, but we can improve information.

Just as in our physical environment, the rules and functioning of the economy are essentially constant, unaffected by our day-to-day considerations about our work, leisure, saving, and consumption. It is always unique or superior information that helps us make better decisions. And, even our choices in politics are one way we express our understanding of what harms or helps us within the Econosphere. In the same way that someone can avoid chemicals that harm the physical environment, you might also vote against a candidate who proposes policies that might impede the proper functioning of the economy by encouraging or discouraging certain kinds of production or consumption, or in adversely changing the way that the economy distributes scarce resources.

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