Efficient Markets & Economists as “Traders”

There’s a bizarre contradiction held in many economic commentaries.  This is the view espoused by economists who believe in the Efficient Market Hypothesis and, at times, claim they can utilize their expertise to take advantage of market inefficiencies and more commonly, propose policies that are the economic equivalent of being able to accurately predict and identify some “disequilibrium”.

For instance, in a post today, Scott Sumner says that his blog “consistently offers good investment tips.”  Of course, this is the same staunch EMH defender, Scott Sumner who says “Defending the EMH is a lonely crusade that can only end in tears and ridicule, unless you are Eugene Fama, in which case it ends in a Nobel Prize and ridicule. ”   I suspect that Eugene Fama doesn’t rely on Scott Sumner’s comments section to make his portfolio allocation decisions and in fact, I suspect Eugene Fama would fall out of his chair laughing at the idea that anyone can make a profit trading on ideas in an economics blog comment section.  You can’t make this stuff up….

But this also raises another interesting contradiction in economics.  That is the idea that the economy is generally in a state that doesn’t resemble equilibrium in the short-run and that policy can be utilized to bring it back to some form of equilibrium.  Of course, this assumes that some omnipotent entity or group of people can identify the disequilibrium before the fact and set the economy on a corrective path.  This is the economic equivalent of “trading” since traders essentially try to identify short-term inefficiencies in an attempt to beat the market at discovering some equilibrium point.  When it comes to policy recommendations economists are quick to claim they have all the answers and can identify market disequilibriums before the fact.  But when it comes to trading markets they often laugh and ridicule Wall Street’s traders for trying to identify and take advantage of the same thing.

In the case of many economists you get a strange contradiction that exposes some extremely muddled thinking.  But that’s basically what modern economics is.  A strange muddled set of contradictions that doesn’t really help anyone understand much of anything and instead generally promotes some set of policy ideas that are essentially just confirming that economist’s preconceived political biases.

NB - Sumner’s figures in his congratulatory comment are also wrong. The consensus was not “well above 3%”. That figure was the Q2 figure referenced in this WSJ piece which Sumner linked to.  The consensus for Q1 was 1.1% in RGDP and 1.7% on NGDP. The actual came came in at 0.1% on RGDP and 1.3% on NGDP. The blog commenter Sumner congratulates called for -1.4% RGDP and 0.5% NGDP which means that he was much more wrong than the consensus.  Maybe market participants don’t digest information all that efficiently after all – including GDP articles that were published three weeks ago?


Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  1. How do these guys write this sort of stuff without even seeing all the contradictions in their own views. I am becoming convinced, like you Cullen, that economics is almost all one big policy stunt masquerading as scientific work.

    • Maybe he’s thinking of starting a subscription based stock service given his popular blog?

  2. Sumner’s comments are even weirder since he advocates a market based solution to NGDP targeting and EMH is a core piece of the rationale for doing so.

  3. In fairness to Sumner, I doubt he would really advocate using his blog as a source for trading ideas. And I also think it’s worth noting that he does think NGDP targeting is best achieved through the use of a market based mechanism. There’s no predictive nature in that mechanism other than the market itself.

  4. The EMH is a colossal intellectual fraud — It is not a theorem, a law of nature, or a logical proposition. It is, as the word says, no more than a hypothesis, or conjecture, and a massively inconsistent one. The reasons is that academic economists tried to borrow models from science and apply them to economics without understanding the physics first. In fact, they have understood nothing of what constitutes an equilibrium process in science.

    • It’s very simple really. A lot of mainstream economics is an attempt to conform the idea of rational expectations with specific policy ideas. There’s an internal inconsistency in the idea that markets are better at making decisions when combined with the reality that the world is a very fucked up place (pardon my language Cullen).

    • I learned something from the efficient markets hypothesis.

      Phrase it as a syllogism:
      (1) everyone has perfect information,
      (2) nobody can beat the market

      Now, (A) We know people can beat the market.
      So take the contrapositive of the EMH:
      (a) someone can beat the market,
      (b) people do not have perfect information.

      In practice, you can make a stronger statement:
      (a) someone can beat the market,
      (b) that someone has better information than the average person in the market

      In short, you can analyze all market-beating effects and all “bad pricing” in terms of information failures. I think that’s useful.

      When I think I’ve got a market-beating scheme, I go “What is it that I know that they don’t know? And why don’t they know it?” Once I’ve identified what I know that they don’t know, and why they don’t know it, I can be pretty assured that my scheme has a decent chance.

      Sadly, this is not the direction which the worshippers of efficient market theories go in. Sigh…

  5. Precisely. Because if they knew exactly what to do, and moreover recognizing WHEN to do it, we wouldn’t be agonizing about CB decisions and utterances over, and over, and over again.

  6. 30+ comments on the Sumner post and none of them pointed out that the 3% RGDP consensus quote is wrong. Maybe Market Monetarists aren’t very efficient market thinkers?

  7. LOL. Cullen, you’re going to drive yourself mad reading all these economics blogs!

  8. “generally promotes some set of policy ideas that are essentially just confirming that economist’s preconceived political biases.”

    I would often say, rather, “that economist’s pre-paid political biases”.

    There is big money in promoting silly ideas like the Efficient Markets Hypothesis; it is used as a political cudgel to dismantle regulation and rig the markets in favor of certain people who are already very rich. Those very rich people (Charles and David Koch, for instance) are happy to pay to endow economics department chairs for espousing the doctrines which benefit them politically.

  9. “The consensus for Q1 was 1.1% in RGDP and 1.7% on NGDP.”

    Huh? The article you linked to shows a consensus 1.1% RGDP growth and 1.7% inflation, so about 2.8% NGDP growth.