The incorrect Efficient Market Theory (EMT) defines markets as being in equilibrium and if unexpected events cause disequilibrium, it is only fleeting, that is, markets are self-adjusting. Asset prices “fully reflect” all available information and properly represent each asset’s intrinsic value. As a result, prices are accurate signals for correct resource allocation. In addition, stock prices move randomly, therefore, “you cannot beat the market.”
US economic leaders such as Federal Reserve Chairperson Bernanke and Treasury Secretary Geithner believe the EMT best describes how markets work. Therefore, they think the stock market is a large casino where asset bubbles cannot arise. Economists’, and the politicians they advise, faith in "all-knowing markets" leads Congress to repeal the Glass-Steagall Act in 1999, which protects us from banking excesses. The Commodity Futures Modernization Act of 2000 law passes, which forbids the US government from regulating swap derivatives. In addition, this law revokes state and local laws regulating gambling bucket shops, created to correct the excesses of the credit crisis panic of 1907. Both laws need reenacting.
The Technology Bubble in 2000, as well as many bubbles throughout history happens (John Law’s Mississippi Scheme, South Sea Bubble and Holland’s Tulip Mania). Now the Real Estate Bubble, where home prices nationally declined roughly 30% since June of 2006, with another 15% drop in prices expected. The US government’s use of anywhere from $24-to-$39 trillion taxpayer dollars and Federal debt guarantees to stabilize the financial markets are valid examples that major asset bubbles occur. In addition, markets are not self-equilibrating and investors cannot always trust market prices for accurate resource allocation.
The EMT is inaccurate. The US government’s use of multiple stimulus packages, keeping too-big-to-fail zombie banks alive, setting a zero-to-0.25 percent federal funds interest rate, not re-regulating the financial markets and using more-and-more government debt to mask the credit crisis is improper and dangerous. Tragically, the US is mimicking the policies the Japanese are using, trying to solve their credit crisis real estate bubble. This is resulting in Japan’s 22-year secular bear market. During October 2012, the Nikkei Index is about 8,850, down 77% from its high of 38,916 on 12/29/89. Thus, I expect a US secular bear market to extend until 2027, if the politicians in Washington do not change their policies.
1) Prentis, E. L. (2012). Early Evidence on US Stock Market Efficiency: "Market vs. State" Debate and Deregulation Implications. Economics and Finance Review, Vol. 2, No. 8, p. 23-34.
2) Prentis, E. L. (2011). Evidence on a New Stock Trading Rule that Produces Higher Returns with Lower Risk. International Journal of Economics and Finance, Vol. 3, No. 1, p. 92-104.
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