According to Paul Krugman and a great many liberal economists, the salient intellectual point of the financial meltdown is that it exposed the hollowness of the “efficient markets hypothesis.” This theory, devised by Robert Lucas of the University of Chicago, suggests that efforts to use the levers of government to move markets in certain ways and certain directions are bound to fail because the markets, in their collective wisdom, will always manage to “price in” future changes and thereby blunt their impact. Since the market failed to see the September 2008 crisis coming, and thereby failed to price it in, the meltdown was terrifying and reveals the flaws in the theory—and, by extension, its line of attack against government intervention.
Well, here we are on October 14, 2009, and the Dow Jones Industrial Average is once again above 10,000. This will surely be grounds for rejoicing among people who are supportive of the president’s claims to have stabilized the economy and put it on a favorable path. (To be fair to Krugman, though, he is unlikely to be among them—he’s very disappointed in Obama from the Left.) It will certainly be a good talking point. And yet what is on display in this seemingly nonsensical rise of 10 percent in the value of the Dow over the past few weeks? Nothing more than speculation that certain numbers look promising going forward. In other words, what we have here is a case of the “efficient markets hypothesis” working for the benefit of a Democratic politician, in that the collective wisdom of the market has it that the economy is going to grow at some point relatively soon and that the time to buy is now, so that stocks don’t get more expensive later.
So will those who claim that the post-Friedman Chicago School of Economics has been discredited still revel in the Dow’s potentially catastrophically premature climb, or will they find themselves explaining that the markets know best?