The media often portrays the stock market as a casino. That
attitude first gained academic cover with J. M. Keynes. Ludwig Lachmann wrote,
“Thus, seeing the importance of expectations in asset markets, and disliking
the implications of what he saw, he launched his famous diatribe on the Stock
Exchange as a ‘casino.’”[1]
Here are excerpts from Lachmann’s defense of the stock market against Keynes’
assault:
“Furthermore, in his Chapter 12 on ‘The State of Long-Term
Expectation,’ the famous diatribe against the Stock Exchange, it becomes
painfully evident that Keynes failed to grasp the nature of the problem posed
by the existence of inconsistent expectations. Instead of studying the process
by which men in a market exchange knowledge with each other and thus gradually
reduce the degree of inconsistency by their actions, he roundly condemned the
most sensitive institution for the exchange of knowledge the market economy has
ever produced! [2]
“The Stock Exchange is a market in ‘continuous futures’. It
has therefore always been regarded by economists as the central market of the
economic system and a most valuable economic barometer, a market, that is,
which in its relative valuation of the various yield streams reflects, in a
suitably objectified’ form, the
articulate expectations of all those who wish to express them. All this may
sound rather platitudinous and might hardly be worth mentioning were it not for
the fact that it differs from the Keynesian theory of the Stock Exchange which
is now so much en vogue.
“In order to defend our own view it is therefore necessary
to enter upon a critical discussion of the Keynesian view of the economic
function of the Stock Exchange. This view is summed up in the famous sentence, ‘When
the capital development of a country becomes a by-product of the activities of
a casino, the job is likely to be ill-done.’ How did Keynes arrive at this
conclusion?[3]
“Far more important is Keynes’ attitude to the fundamental
question: Is the Stock Exchange a suitable instrument for bringing long-term
expectations into consistency; is it capable of giving rise to a, socially
‘objectified’, market opinion to guide investment decisions? Here Keynes’
answer is a clear and unqualified ‘No’. ‘For most of these persons are, in
fact, largely concerned, not with making superior long-term forecasts of the
probable yield of an investment over its whole life, but with foreseeing
changes in the conventional basis of valuation a short time ahead of the
general public.’ This is ‘an inevitable result of an investment market
organized along the lines described. For it is not sensible to pay 25 for an
investment of which you believe the prospective yield to justify a value of 30,
if you also believe that the market will value it at 20 three months hence.’[4]
“It is readily seen that the defect criticized by Keynes is
not a defect of investment markets as such, but a defect of investment markets
without a provision for forward trading. Where forward trading exists, a person
holding the views described could express his short-term view by selling the
investment at any price above 20 for three months ahead, while expressing his
long-term view by buying it, say, 18 months forward at a price below 30. If
everybody did it arbitrage would do the rest by bringing the forward prices for
various future dates into line with each other. Price expectations involve
intertemporal price relations, and intertemporal price relations cannot be made
explicit, hence cannot be adequately expressed, without an intertemporal
market. All we can conclude from Keynes’ argument is not that the Stock
Exchange cannot make yield expectations consistent, but that without forward
trading it cannot do so.”
“But this is not all. Keynes not merely failed to realize
the real nature of the specific problem he was facing, viz. intertemporal price
inconsistency expressing itself in divergent expectations. He was probably
unaware of the importance, perhaps even of the existence, of the class of
problems of which this is one: problems of the transmission of knowledge. There
is very little evidence that he grasped the economic
function of the market as an institution through which people exchange
knowledge with each other. The Keynesian world is a world in which there are
two distinct classes of actors: the skilled investor, ‘who, unperturbed by the
prevailing pastime, continues to purchase investments on the best genuine
long-term expectations he can frame’; and, on the other hand, the ignorant
‘game-player’. It does not seem to have occurred to Keynes that either of these
two may learn from the other, and that, in particular, company directors and
even the managers of investment trusts may be the wiser for learning from the
market what it thinks about their actions. In this Keynesian world the managers
and directors already know all about the future and have little to gain from
devoting their attention to the misera
plebs of the market. In fact, Keynes strongly feels that they should not!
This pseudo-Platonic view of the world of high finance forms, we feel, an
essential part of what Schumpeter called the ‘Keynesian vision’. This view
ignores progress through exchange of knowledge because the ones know already
all there is to be known whilst the others never learn anything. The view
stands in clear and irreconcilable contrast to the view of the role of
knowledge in society we have consistently endeavoured to set forth in this
book. The reader will not be surprised to learn that our conclusions on the
subject of the Stock Exchange are equally irreconcilable with those of Keynes.
“We hold that the Stock Exchange by facilitating the
exchange of knowledge tends to make the expectations of large numbers of people
consistent with each other, at least more consistent than they would have been
otherwise; and that through the continual revaluation of yield streams it
promotes consistent capital change and therefore economic progress. This, of
course, is not to say that the Stock Exchange makes inconsistent capital change
impossible: merely, that company directors who ignore the signals of the market
do so at their peril, and that in the long run a market economy substitutes
entrepreneurs who can read the signs of the times for those who cannot.”[5]
[1] Ludwig M. Lachmann, Capital, Expectations, and the Market Process, Kansas City: Sheed
Andrews and McMeel, 1977, 161.
[2]
Capital, Expectations, 142.
[3]
Ludwig M. Lachmann, Capital and Its
Structure, Kansas City
[4]
Capital and Its Structure, 69-70
quoting J. M. Keynes: General Theory of
Employment, p. 155.
[5]
Capital and Its Structure, 70-71,
quoting Keynes, General Theory of
Employment, 156.
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