Candy Kisses Jude Wanniski May 18, 2005

Memo To: Website Fans, Browsers, Clients
From: Jude Wanniski
Re: The Amazing Efficient Market

Why is there so much poverty in the world? Economists will say it is because of corrupt or venal politicians, who will not do what has to be done to produce a world of milk and honey, an end to poverty. Politicians have their problems, I would agree, but if the economists were any good, their prescriptions would produce milk and honey and the politicians would revel in the acclaim of their constituents. When the politicians do follow the counsel of the economists, in most cases things get worse, not better. First the stock market falls, then the economy sinks. The economists fallback position is always that the market is inefficient. There are stock market "bubbles" followed by "crashes," with "irrational exuberance" part of the euphoric mix, and bubbles punctured for quite unknown reasons.

On March 12, 1999, I wrote a memo on the margin in this space directed to Joe Stiglitz, then the chief economist of the World Bank. In my view he is not a very good economist, even though we had common ground in agreeing that the World Bank was making poor countries poorer. Stiglitz subsequently won the Nobel Prize in economics for the body of his career work, which is that markets are inherently inefficient. Markets are composed of people, and we all know that most people are dummies, so it is no surprise that there are booms and busts on Wall Street. I actually know Stiglitz, who is now at Columbia University teaching youngsters about the inefficiency of markets, but I did take a stab with this memo about candy kisses in trying to explain to him why he is flat-out wrong. I don't mind if he keeps the $1 million he got with the Nobel, but he is doing billions, maybe trillions of dollars of future damage by teaching the stuff he does. I wish he would stop.

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1,098 Candy Kisses

Memo To: Joe Stiglitz, World Bank chief economist
From: Jude Wanniski
Re: The Efficiency of Markets

A story about you and your fight with the economists at the IMF in the March issue of International Economy came to my attention the other day. I'm delighted that someone at the World Bank is trashing the incompetence at the IMF, especially Stanley Fischer and Michael Mussa. But Joe, I'm sorry to tell you that I can't see where your "different" policy recommendations would make much difference to the poor countries of the world. In reading the article by Neil Ullman, I had the feeling I was reading the proceedings of a convention of Ptolemaic economists. The IMF says the sun revolves around the earth and the World Bank says that while this is true, the moon revolves around the sun. Ullman seems to think you deserve a Nobel Prize for your lifelong work in proving that markets are inefficient and must be regulated by wise men with salt-and-pepper beards, like yours.

It just so happens I was having lunch in Manhattan last week with J. Danforth Quayle, our former vice president, who has developed a healthy skepticism of the work of both the IMF and World Bank. We discussed the efficiency of both the financial markets and the political markets, as I had just replicated an experiment first tried 150 years ago. I'd learned from Peter Bernstein, the Wall Street guru, that a mid-Victorian genius named Francis Galton had an intuition about the ability of large numbers of people to be superior to individuals in making certain kinds of judgments. Galton, by the way, is the fellow who also realized fingerprints could be used to track down criminals and who coined the term "eugenics," thinking he had learned something useful about genetics from his first cousin, Charles Darwin. In any event, according to Bernstein, Galton went to a fair outside London and saw on display a bull, with the offer of a prize to whomever could come closest to guessing its weight. When the fair ended, Galton asked for the box with the names of the guessers and their guesses. He added the total of all the poundage guessed and divided that large number by the number of guessers -- and found that while not one person guessed the exact weight of the bull, in the aggregate they hit it spot on!

What an incredible discovery! It is one that led Jack Treynor, now a retired professor of finance in Southern California and former editor of the Financial Analysts Journal to teach his students about the incredible efficiency of markets. He would pass around a jar of jelly beans to his students and have each guess the number. Invariably, he told me, the class would guess the correct number within a 5% range. When I heard about this, I decided it was a proof of democracy as well as a proof of the efficiency of the economic and financial marketplace. It shored up my own intuitive sense, which I expressed in my 1978 book, The Way the World Works, that if the electorate were given all the relevant information about competing political candidates, they would always choose the best one.

Oh yes, replicating the Galton experiment. It happens that my son Andrew manages a large Tex-Mex restaurant in Cedar Knolls, N.J., the Sagebrush Steak Cantina. At the door as you leave, there is a large bowl of candy on display, with customers invited to guess the number of candies therein. Sometimes gumballs, sometime candy canes, but last month candy kisses. I asked Andrew if he could save the results and the slips of paper with the guesses. The day before my lunch with Dan Quayle I sat down and added up all 478 guesses and found they totaled 522,932 kisses. The customers in aggregate had guessed 1094 kisses. The correct number, which no single customer had guessed, was 1098. I'd tried the experiment before with smaller numbers of people and it worked as Treynor had indicated, but this was about as good as it gets. If you have never heard of this phenomenon, Joe, I suggest you study it very closely, as it demonstrates that your life work in proving the inefficiency of markets may need some work. Your recommendations suggest a small number of people working for a government or an international institution are superior at allocating capital than the market is. If you are wrong, you are as dangerous as Stanley Fischer, Michel Camdessus, and the IMF maniacs.

As for the political markets, I explained to Quayle that he should not be concerned that George W. Bush has collected the endorsements of a hundred leading wise men with salt-and-pepper beards, and a few ladies too. The fact is, they have endorsed him without knowing what he believes, which is like asking folks to guess the number of candy kisses without showing them the bowl. The prize will go to the presidential candidate who is best at showing the bowl of candies to LARGE numbers of people. Ronald Reagan understood this in early 1980, when Fortune magazine reported that only three chief executive officers of the Fortune 500 endorsed his candidacy, preferring George Bush or John Connally. I was standing next to the Gipper when his press secretary, Jim Lake, told him the bad news. Reagan laughed and told Lake not to worry: "Jim, I'm going to be the candidate of the shopkeeper, the farmer, the independent, the entrepreneur. There are a lot more of them than CEOs of the Fortune 500." That's no bull.