Saturday, May 21, 2011

Okay, I'm a Sucker Too

     I went to business school in the late 1970s when one of the principle assumptions about people is that they are rational creatures. They seek to maximize the benefit of any transaction they make, from buying a soda to deciding whether or not to get married. This evolved into the efficient market theory, which claims that the price of something -- particularly stocks, bonds and commodities -- reflects everything that everyone knows about the situation at hand.

     Now that I'm older and have some worldly experience, I realize that this economic assumption is terribly naive and simplistic. But, really, I always knew in my gut that people are not that rational. And to just proclaim that prices reflect all known information has to be some kind of tautology. I'm not even sure what a tautology is, as a technical epistemological term, but it has something to do with circular reasoning, that the conclusion is embedded in the question, that the premise is "logical" but it makes no sense in the real world.

     But consider this:  A study at UCLA has shown that the price of orange juice futures is a more accurate predictor of the weather in Florida than the actual weather report. It seems that all those people betting on the future of Florida weather, who've put their money where their mouth is, do a better job sifting through all the information and making a prediction, than the people who are consulting their computers and their weather maps and reporting their conclusions to the weather bureau.

     But then, how do you explain the NASDAQ bubble of the late 1990s, or the housing bubble of the early 2000s? Or, perhaps, the gold bubble of today? (What do you do with gold anyway? I don't get it.)

     I know how to explain it. People are crazy! You gotta love 'em, but they believe in all kinds of nutty theories; they base a lot of decisions on emotions rather than facts; they select the information they want to believe based on their own prejudices and personal experiences; they tend to follow the herd. Some people are too stupid to pursue their own best economic interests. Some people are just too lazy.

     Yale economist Robert Shiller explains the irrationality of bubbles by saying they are a kind of Ponzi scheme. The people who get in early on a bubble identify a legitimate economic situation, and they make a lot of money as other people recognize the opportunity and bid up prices. Eventually prices outrun the original economic thesis -- yet prices keep going up, just because investors see prices rising and assume they will keep going up and so they continue to jump in. But inevitably people realize the new economics don't support the new prices. The bubble bursts and prices plunge, until all but the original investors who got in at a low price lose money. These bubble prices are not efficient. They are illusory.

     The fact is, people have limited ability to obtain information and figure out what it means. They act on their emotions; and their behavior is influenced by cultural influences; or their own sense of self-worth. How else to explain why a person pays an exorbitant price for a car, or a collectible, just to prove that they can afford it? That's not rational, that's egotistical. Or what about people's lack of self-control -- when they order a third martini, even though they know they shouldn't, or buy yet another pair of shoes when they have no use for them?

     Still not convinced? Just reflect on how many people believe in astrology, or UFOs or that Paul is still dead. Or that the world is going to end today, or tomorrow, or the next day.

     There's a lot of stupidity out there, a lot of gullibility, a lot of paranoia. A lot of emotion. And yours truly is not immune to letting emotions overrule his rationality. For example, I know that traveling in an airplane is the safest form of transportation, that you're more likely to die in the car on the way to the airport than you are in the airplane on the way to California. Nevertheless, you won't find me on an airplane anytime soon. No one's going to lock me into an aluminum can and send me 30,000 feet up in the air with a pilot who's probably been drinking, a maintenance crew that's on a work slowdown and an air traffic controller who's sawing wood in the control tower.

      I understand my view toward airplanes is not rational. Nevertheless, that's how I feel.

     There is one exception to this rule. It's that new putter down at the GolfPro store. I'm a mediocre golfer and a lousy putter. I've been through at least 20 putters in my day, and each time I've been absolutely certain that the new putter will transform my golf game. Each time I've been tragically disappointed.

     However, that new putter down at GolfPro has such a great feel to it. It fits my hands perfectly. Plus, it's $140, which is twice as much as I've ever spent on a putter before. If it's that expensive, it gotta work. Don't you think?

     [A slightly different version of this article was first published as "I'm a Sucker, but Not for Gold" on Technorati.]

8 comments:

rosaria said...

What a brilliant analysis! And yes, people are both rational and irrational, and when it comes to purchasing, other factors jump in, like our self concept, our ambitions, our greed, etc.

Now, what is that putter that will change your game?

Dr. Kathy McCoy said...

Fascinating post -- and so true! My irrational equivalent of your putter is diet books. They hold a kind of crazy magic for me even though I know my best path to a healthy weight is to keep exercising and eat a moderate amount of healthy foods. I know that and yet....

schmidleysscribblins.wordpress.com said...

Wow, what and interesing blog and so well written i could not stop reading. So many things to respond to, I don't know where to begin. I know people are not rational.

As a sociologist, I agued with the economists I worked with at Bell that people make weird decisions but in the aggregate they do tend to behave in patterened ways, like eating three meals a day.

Is that rational, when nutiritionists tell us we would do better to eat six small meals per day? I knock on wood and do not step on cracks in the sidewalk. I will never stop these practices. I also keep a quartz crystal in my car to ward off evil. It works as well as the St Christopher medal my dad used.

Kay Dennison said...

You've expressed this so well!!! We women do stuff like that when we look longingly at the potions at the Clinique counter wondering if that 60-dollar cream will make us look 10 years younger or buy the pants that they tell us will make our but look smaller. It's called hope and that's not a bad thing.

Retired Syd said...

I don't get it with gold either. Really, I don't.

Linda Myers said...

I persist in thinking that if I put "Gym" on my computer calendar for Tuesday, Thursday, and Saturday, it means I will actually go.

Anonymous said...

Of course people are crazy. Look who they voted for to be our current president. And, they just might be crazy enough to re-elect him.

Robert the Skeptic said...

My last recent blog posts have been examining this very thing; how difficult, if not impossible, it is to be completely rational or make decisions devoid of emotional bias... and whether it is even a good thing to do so or not.

The reality is that we are naturally pattern-seeking creatures, our brains are hard wired to make connections and come to conclusions. Most of them are right but sometimes they are wrong. We see this often in examples of the orange juice and weather example, we attribute causation where there is often only correlation. The best we can hope to achieve is to get it right more often than not. That takes effort.