I TOLD YOU SO-Seven Habits of Highly Defective Investors-Paul Krugman
Writing in the most recent issue of ''The International Economy,'' William Greider used the occasion of Asia's economic crisis as an opportunity to settle some scores with conventional economists who scoffed at his 1997 book ''One World, Ready or Not: The Manic Logic of Global Capitalism.'' ''They're not scoffing now,'' he declared. As it happens, he's wrong: they're still scoffing. Conventional economists never denied that crises happen; it was his explanation of why and how that they thought was silly.
In one sense, however, Greider has moved into the mainstream. Over the last few months there has been a flood of columns and essays about the lessons of Asia's economic woes. As far as I can tell, every pundit draws the same central lesson Greider did: whatever he thought before about the way the world works, whatever economic doctrine is identified with his name - the crisis proves that he was right. Practitioners of at least four schools of economic thought, who rarely agree about anything, have managed to find confirmation of their faith in Asia's misfortune:
*Champions of Capitalism. On the eve of the crisis, free-market enthusiasts were cheerfully announcing that, as The Wall Street Journal put it last March, the worldwide turn to free markets was fueling ''a global growth wave that is unprecedented in size and scope.'' The main reason for that high global growth rate was, of course, the extremely rapid growth of emerging Asian economies. When those economies suddenly went into reverse, did the global capitalist faithful question their confidence in the power of free markets? No, clearly the trouble with Asian economies was simply that their markets weren't free enough. Before the crisis they were advertisements for the power of capitalist thinking; afterwards, anyone could see that they were hotbeds of ''crony capitalism,'' a far cry from the real thing. And the crisis proves the superiority of the genuine article.
*Global glutters. Greider is only one of a number of people who worried that multinational corporations were building more manufacturing capacity than the world could possibly use. And they have no doubt that this crisis - even though it seems to have been largely driven by real-estate speculation, and even though the most conspicuous examples of over-investment involved local businessmen rather than multinational corporations - shows just how right they were.
*Asia-phobes. Until just a couple of years ago you couldn't open the pages of a public-affairs magazine without running into a commentary by one of the ''revisionists,'' who claimed that Japan and other Asian countries had developed a new and superior form of capitalism that was beating the pants off Western, free-market economies. You might have expected the leading revisionists to admit to having gotten it a bit wrong, or at least to show some signs of diminished confidence in their own judgment. But no. For the most part they are still opining as freely as ever.
James Fallows, the editor of U.S. News & World Report, declared as late as 1994 that ''Like it or not, we live in the world that Asian success stories have shaped. We need to figure out how to compete in it.'' Now, while conceding some flaws in the Asian model, he still warns that ''During seven years of unremitting distress for its financial system, Japan's manufacturers have accumulated trade surpluses of more than $700 billion.'' (Shouldn't this make him wonder whether trade surpluses are necessarilysuch a good thing?)
Others have managed to change tune without missing a beat. Clyde Prestowitz, whose 1988 book ''Trading Places'' predicted that Japan's government-business partnership would allow it to dominate high technology at America's expense, now declares that ''The Japanese model was a fantastic catch-up model, but it was not a model for all seasons,'' and has taken to denouncing crony capitalism and sternly lecturing Japan on the need for fundamental reform.
*Asia-philes. A larger, more diffuse group than the revisionists, this includes just about everyone who believed that Asia's past growth rates could be extrapolated into the future (without necessarily believing that the region's success was based on some novel form of capitalism, or that it had been achieved at Western expense). One of those, Jeffrey Sachs, is the Harvard professor who led a team that compiled last year's ''Global Competitiveness Report,'' with its Asia-friendly rankings. Did the crisis shake his conclusions? Not at all. It simply proved to him what he always knew, that even the strongest of economies can be devastated by a financial panic. And of course some Asian leaders, like Malaysia's Mahathir Mohamad, see not just panic but conspiracy at work.
Part of the problem, presumably, is that there is no licensing requirement for economic commentators; there aren't many economics professors among the global glutters or the Asia-phobes, but that doesn't stop them from adding to the cacaphony. A bigger part of the problem is that economics is for the most part not the kind of discipline where you can do an experiment that settles an issue beyond all dispute. True, you can get a bunch of undergraduates to buy and sell a fictitious commodity, or bid in a simulated auction; but you can't persuade the International Monetary Fund to rescue only half of the economies in crisis, using the rest as a clinical control group. All that we have are the lessons of history - lessons that are often positively Delphic in their obscurity. But even when history might seem to you or me to be speaking loud and clear, it is no match for the ingenuity of modern punditry, which can turn any event - no matter how much it may seem, on the surface, to contradict what the pundit was saying a few months ago - into an occasion for triumphant self-congratulation.
Oh, by the way, what about me? Back in 1994 I published a notorious article entitled ''The Myth of Asia's Miracle,'' which many people now credit with having forecast the current crisis. A close reading of that article might suggest that to the extent that I predicted anything, it was a gradual slowdown - not the sudden catastrophe that has overtaken the region. But, hey, I'm tired of fighting conventional wisdom. This time I'm ready to go along with what everyone believes: recent events prove that I was completely right.
I like the theory of efficient financial markets as much as anyone. I don't begrudge Robert Merton and Myron Scholes the Nobel Prize they just received for showing how that theory can help you price complex financial instruments. But unless you spent the past five months in a Tibetan monastery, you must have noticed that markets have been behaving pretty strangely of late. As recently as June the "miracle" economies of Southeast Asia could do no wrong--investors cheerfully put billions into local stock markets. By October those same investors were in full flight; after all, everyone could see how corrupt and badly managed those economies were. When the IMF and the World Bank held their September meeting in Hong Kong, everyone congratulated the hosts on their economic policies, which had insulated them from the turmoil to the south and maintained prosperity through the handover to China. A month later Hong Kong had not only crashed but had briefly brought Brazil and much of the rest of the world down with it.
Seven Habits of Highly Defective Investors
Paul Krugman
What is the market up to? Well, I recently had a chance to listen to the market, or at least a fairly large part of it, when I attended a meeting of money managers. Collectively they control several hundred billion dollars, so when they talked, I listened. Mainly I wanted to know why such smart men and women--and they must be smart because if they aren't smart, why are they rich?--do such foolish things. Here's what I learned: the seven habits that help produce the anything-but-efficient markets that rule the world:
1. Think short term. A few people in that meeting tried to talk about the long term--say, about what kind of earnings growth U.S. corporations might be able to achieve over the next five years. This sort of thing was brushed aside as too academic. But wait: Any economist will tell you that even a short-term investor should look at the long run. This year's stock price depends on this year's earnings plus what people think the price will be next year. But next year's price will depend on next year's earnings plus what people next year expect the price to be the following year.... Today's price, then, should take into account earnings prospects well into the future. Try telling that to the practitioners.
2. Be greedy. Many of the people kept talking about how they expected a final "melt-up" in prices before the big correction and how they planned to ride the market up for a while longer. Well, maybe they were right, but if you really think stocks are overvalued, how confident should you be about your ability to time the inevitable plunge? Trying to get those extra few percent could be a very expensive proposition.
3. Believe in the greater fool. Several money managers argued that Asian markets have been oversold, but that one shouldn't buy in until those markets start to turn around--just as others argued that the U.S. market is overvalued, but they didn't plan to sell until the market started to weaken. The obvious question was, If it becomes clear to you that the market has turned around, won't it be clear to everyone else? Implicitly, they all seemed to believe that the strategy was safe, because there is always someone else dense enough not to notice until it really is too late.
4. Run with the herd. You might have expected that a group of investors would have been interested to hear contrarian views from someone who suggested that the U.S. is on the verge of serious inflationary problems, or that Japan is poised for a rapid economic recovery, or that the European Monetary Union is going to fail--which would have offered a nice challenge to conventional wisdom. But no: The few timid contrarians were ridiculed. The group apparently wanted conventional wisdom reinforced, not challenged.
5. Overgeneralize. I was amazed to hear the group condemn Japanese companies as uncompetitive, atrociously managed, unable to focus on the bottom line. But surely it can't be true of all Japanese companies; guys who managed to export even at 80 yen to the dollar must have at least a few tricks up their sleeves. And wasn't it only a couple of years ago that Japanese management techniques were the subject of hundreds of adulatory books and articles? They were never really that good, but surely they are better than their current reputation.
6. Be trendy. I came to the meeting expecting to hear a lot about the New Economic Paradigm, which asserts that technology and globalization mean that all the old rules have been repealed, that the inflation-free growth of the past six years will continue indefinitely, that we are at the start of a 20-year boom, etc. That doctrine is basically nonsense, of course--but anyway I quickly determined that it is, as they say in Buffy the Vampire Slayer, "so five minutes ago." All the rules have changed again: Now we stand on the brink of a dreadful epoch of global deflation, and despite its previous track record of engineering recoveries, there is nothing the Fed can do about it. You see, it's a new new economy.
7. Play with other people's money. If, as I said, the people at that meeting were very smart, why did they act in ways that seem so foolish? Part of the answer, I suspect, is that they are employees, not principals; they are trying to make money and careers for themselves. In that position, it is hard to take a long view: In the long run, even if you aren't dead, you probably won't be working in the same place. It is also difficult for someone managing other people's money to take an independent line. To be wrong when everyone else is wrong is not such a terrible thing: You may lose a bonus, but probably not your job. On the other hand, to be wrong when everyone else is right... So everyone focuses on the same short-term numbers, tries to ride the trends, and buys the silly economic theory du jour.
Listening to all that money talking made me very nervous. After all, these people can funnel money into a country's markets, then abruptly pull that money out--and create a boom-bust cycle of pretty spectacular proportions. I don't think they can do it to the U.S.--in Greenspan I trust--but I am not 100% sure.
One thing that I am sure of is that the Asian leaders who have been fulminating against the evil machinations of speculators have it wrong. What I saw in that room was not a predatory pack of speculative wolves: It was an extremely dangerous flock of financial sheep.
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Paul Krugman is a professor of economics at the Massachusetts Institute of Technology.
The above two articles are my selection from some of his great writings. For any one interested in investments Dr Krugman views will help in formulating a cogent and coherent strategy.
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