Today, we can see a lot of confusion in the market. Investors are reading the tea leaves on what Ben Bernanke will do with interest rates, economists are arguing whether the US are in recession or not, the stock market are being tossed and turned by every bits and pieces of economic data and investors are confused and nervous about what is going on. Notice one thing: the market is trying to absorb every piece of economic data (e.g. unemployment level, manufacturing index, GDP, CPI, etc.) and still yet not able to make up its mind on what is happening to the US economy. Given that many highly esteemed economists and analysts have conflicting opinions, how can investors and traders make confident decisions?
These are good questions. Why is there so much confusion?
To answer this question, we will turn to a rare, most hard to find, most buried important book, in the history of the Austrian School
Among these the most important and also the most controversial question is to ascertain whether the method of deductive analysis or that of empirical description offers the better chance of bringing us nearer to a solution of the problem.
R?pk was dealing with the “methodological questions” of economics. In that book, he criticised the then current fashion of method:
It is easy to understand that, in this atmosphere of institutionalized science with its air of exactness and progressive technique, not many escape the temptation to look down upon old-fashioned ” theory,” with its small business unit of the private study, as something hopelessly behind the times and to claim for their descriptive and statistical method a wider field of application than is compatible with the logic of scientific methodology. Instead of confining themselves to the more modest but very meritorious task of collecting, arranging, and interpreting all the available facts and statistical data and of verifying the results of deductive reasoning, these men thought it possible to replace deductive reasoning entirely by their empirical and statistical method.
Methods in economics have largely been overrun by statistics. At least, this looks to be the methods of financial market economists. As R?pk said, the fault does not lie in the empirical and statistical method. Rather, the issue is the myth that deductive reasoning (qualitative analysis) can be supplanted by quantitative analysis. What is the problem with that? R?pk continues,
It was indeed an ingenious idea to apply the principle of nautical astronomy to economic forecasting, but there was one fatal flaw. For as long as we have not made a thorough investigation into the causal relationships between the time-series, the mere temporal sequence does not tell us any more than that something has happened in the past which might not happen in the future if some variables in the causal mechanism should change. But in investigating the causal relationships we are thrown back from statistical empiricism to “theory” in the deductive and analytical sense.
…
By the statistical method, we ascertain facts, but we cannot explain them, i.e., bring them into logical order so that we “understand” them. Only analytical theory can do that, and if there has been, in recent years, any furthering of our insight into the mechanism of crises and cycles, this has been the work of the theorists and not of the empiricists.
This is what we have today. The market is inundated with copious amount of facts and figures but receives very little insight on these numbers by mainstream economists and analysts. Without insights, the market gets tossed and turned by every minute variations of statistical information from economic reports. The end result is confusion and volatility.
That is one of the reasons why we are different from the mainstream.
