The
great Austrian economist Ludwig Lachmann described the way the stock market
works better than any economist I have read. He taught that expectations
play a vital role in coordinating the decisions of entrepreneurs in the market
process. Spot prices communicate important information, but only information
about the past. For the economy to function well, that is, stay out of
recessions, markets must coordinate the expectations of buyers and sellers,
producers and consumers. Recessions are nothing but a failure to coordinate.
Markets communicate expectations through the futures markets,
including options and other derivatives, but primarily through the stock
market.
Following
are excerpts from Lachmann’s books on the vital nature of the stock market to a
well-functioning market economy. Lachmann shows that the market is neither
mechanical, as the EMH suggests, nor irrational as behavioral finance insists.
