In late 2007, the Shanghai stock market was going through a boom. A Professor of Economics was visiting China and there he learnt that everyone, everyone was expecting the stock market to crash after the Olympics in September 2008. In other words, they assumed the market to keep rising like a Diwali rocket till then, and then fall dramatically.
The professor was amused that no one had reasoned backwards from there. Everyone expected the market to fall in September. So, what would happen in August? Wouldn’t they think, “Hey, I don’t want to get too greedy. I know that the index will rise another month, but what if it suddenly starts falling and I am caught short? I had better sell right now and book my profits.”
Now, if many people think so, prices will fall, not in September, but in August. But if everyone knows that everyone else is thinking that way, why would they wait till August? Won’t they start selling in July? And so on, by induction, if people expect the market to tank in September, prices should fall right now.
This is what traditional economics suggests. Behavioural economics argues that the professor’s analysis is incomplete. Obviously, not everyone will decide to sell in August, but some people will. What will happen in the market is the classic battle between greed and fear. Some people, overcome by greed, will hold on in the hope of making even more gains, while some people, overcome with fear, will sell. At some point, fear will overcome greed and the market will crash.
Gaurav non-Sabnis thinks that the use of the man-from-the-past technique in my Pragati editorial “The Case for Freedom” was hackneyed. He is free to think so. He also thinks that my introduction was inaccurate. He is free to think so too as long as he doesn’t mind being mistaken.
Gaurav makes two errors – a misinterpretation and a factual error. The misinterpretation is this: He says that “mismatch between supply and demand must be as old as beginning of trade”. Well, duh. Obviously, a famine is a severe mismatch between the demand for food and the supply of food. If I had said that there is now a greater mismatch than before, it would have been an extremely stupid statement.
Nilu wants to know why I support Meera Sanyal. He seems to have discerned that I support her from the fact that I have joined the Facebook group that says “Meera Sanyal for South Mumbai”. Can’t blame him for that, but I don’t only join Facebook groups when I support those causes. I join them when I am interested enough to track what is happening.
That said, I do support Sanyal, and if I were a registered voter in South Mumbai, I would vote for her. But Nilu asks some valid questions, and here are the answers.
Rishi wants to know how I can claim that the Presidential System underdelivers change, and Ritwik angrily objects to my claim that in the Parliamentary System, the Prime Minister can handpick legislators. Both of them have missed an important qualifier: popular.
Change is rare in any mature democracy. This is as it should be. Obviously, I prefer change in the direction of less government and limited powers and others may prefer otherwise, but whatever the direction of your preferred change, I think that we should be wary of a system where a Chief Executive can, on the basis of just one election, bring about fundamental and drastic change in the structure of the polity.
Lets give it an honest thought. Imagine a situation where gunmen/terrorists had taken a chawl in Bombay hostage instead of the Taj. What do you think would have been the nature of media coverage ?
If he is talking of the Indian media, then yes, they would have covered it almost as breathlessly as they covered the Taj and Oberoi standoffs.