Here’s the Economist:
JOHN KENNETH GALBRAITH, a quotable economist, observed that one of the deeper mysteries is why, in a falling market, there is still a buyer for every seller. It is a conundrum that bond investors must now contemplate. Since January the yield on a ten-year Treasury bond has risen (and thus bond prices have fallen) with scarcely a backward step. It is above 3% for the first time in years.
At first glance that does seem like a puzzle; why would someone want to buy an asset whose price is falling? But on closer inspection Galbraith is wrong; there is no mystery. He overlooked the Efficient Market Hypothesis.
Here the English language is a bit ambiguous. When people talk about a “falling market”, do they mean a market that “has fallen” or one that “will fall”? In ordinary usage, the term ‘falling’ implies both, as falling physical objects in space have momentum, and hence are likely to keep falling for at least the next second or two.
But asset prices are not like physical objects. In the asset markets, it would be more accurate to say a price “has fallen” rather than “is falling”. Thus it’s not obvious why someone would not want to buy into a falling market. The same is true for rising prices. If Galbraith believed that it is hard to explain why people would buy into a falling market, shouldn’t he also have argued for the opposite in a rising market? Why would anyone not be a buyer in a rising market? Indeed why not buy into an asset price bubble, which is a “rising market”?
I don’t believe that this was Galbraith’s view of bubbles—indeed he occasionally predicted that asset prices were in a bubble that would soon burst. So his view of asset price movements seems confused, worrying about momentum on the downside and worrying about a lack of momentum in bull markets. Perhaps that reflects the fact that it is more intellectually fashionable for intellectuals to be pessimists.
PS. Please don’t cite academic studies of asset price movements, as those studies are not likely to be useful for current investments. They report on past patterns observed in asset markets.
READER COMMENTS
Brian Donohue
Jun 1 2018 at 1:19pm
Very good point about the asymmetrical thinking among bubbleologists and others. I think we are wired to be more attuned to bad things (predator lurking) than good things (fruit tree yonder.)
MikeP
Jun 1 2018 at 1:32pm
There are a lot of things you can say about John Kenneth Galbraith as an economist, but — being his own observation — that one may take the cake.
Kevin Erdmann
Jun 1 2018 at 1:36pm
This is why the FOMCs use of the phrase “the housing correction is ongoing” in 2007 was inadvertently calibrated to invite disaster.
Pierre Lemieux
Jun 1 2018 at 1:53pm
I had also wondered about this when I read the Economist article. I had just put it on Galbraith general state of confusion!
bill
Jun 1 2018 at 2:41pm
There are also people that won’t buy if “prices are falling” AND also won’t buy if prices have “already” risen (out of fear of buying too late).
Charlie
Jun 2 2018 at 2:14am
It’s an especially weird quote to apply to bonds. In nominal terms, the 10-year treasury is close to risk free at the ten year horizon. If bond prices keep falling, the bond yield (mechanically) rises to guarantee the investor an nominal return of 3% a year over the ten year horizon.
So the obvious answer is just someone that finds a particular interest rate attractive enough to delay consumption today for consumption ten years from now. We tend to think of the short term treasuries as being less risky than long term treasuries, but it’s important to remember that if your investment horizon is 10 years (say for instance your 8 year old is off to college in ten years), it’s the 10 year treasury that’s risk free in nominal terms and even a 10 year TIPS that is risk free in real terms,
Charlie
Jun 2 2018 at 2:33am
*I’ll just add the footnote that this holds exactly (conceptually) for a zero coupon bond. The semi annual coupons that Treasuries pay change the effective horizon and add reinvestment risk. Granted if this is the first thing you thought of, you can probably already think through the implications.
Robert Schadler
Jun 2 2018 at 8:52am
A wonderful and profound insight!
My wish is that it would be extended, by classical liberals especially.
Yes “falling” is a slippery concept: dynamic or static (i.e. in the process of falling farther or having already hit bottom).
Likewise, however, the concepts of price and market.
A “price” is both static and dynamic: it some situations it is fixed, take it or leave it; in others, simply a starting point to bargain or “higgle haggle.”
A “market” may designate a human construct where exchanges occur (i.e. a static platform or institution where humans interact) or the sum of all those interactions. This latter being, often, well beyond human understanding (Hayek). The effort is then to derive meaning from the totality of that market (e.g. it is “falling”). That is an attempt to move from micro (each individual transaction) to macro (“the market).
But often we overreach to think we see a single trend or meaning from the exchanges of thousands of individuals each with their own reasons for doing something.
Scott Sumner
Jun 2 2018 at 12:07pm
Everyone, Thanks, Lots of good comments.
Vancouver Dispensary
Jun 4 2018 at 9:56pm
Really enjoyed this blog article. Really Great.
Comments are closed.