Why Are The Markets Wrong?

The role of the market as a creator and processor of information is central to Austrian economics. Prices should reflect the collective evaluation of everyone in the market as they utilize their own constrained resources. While the Austrian theory holds the market to be an important creator of information, it does provides a compelling answer to the mainstream emphasis on perfect information in the market. Mainstream theories understand that the market is not full of people with perfect information, yet they still have a general bias to believe that people will be right as a whole as they will not deviate from the truth in one standard way. The Austrian theory accounts for limited information and the inability of individuals to consistently respond correctly to this limited information. Additionally, Austrian theory understands that when certain actors outside of the market add artificial disruptions to interest rates and monetary factors, people are unable to price assets effectively. Forces outside the market and imperfect information allow the market to be wrong while still being a powerful force for the creation and dispersal of information.

Austrian theory primarily differs from mainstream theory on information in the market by emphasizing the availability of information as well as the ability of individuals to act correctly on that knowledge. There are two types of hidden information. The first being information that is truly unknown, not known by any human, not knowable by any human. This is the sort of information that describes how open ended future events will go or the variety of subjective factors that lead to any macroeconomic crisis. The second type of limited information is information that is known by someone and or able to be known, but not fully distributed. No information is ever truly fully distributed, but some information is simply constrained to smaller pockets of people. Austrian economics emphasizes this fact, as it is what allows entrepreneurs to find opportunities. The world is full of more radically different forms of information than mainstream theory can account for. From tacit knowledge to ancient texts, information varies in its accessibility and the market can fail to utilize it effectively.

People fail to access information that would lead to accurate asset prices, but often they do not even understand the implications of the information they already have. The idea that human rationality is so linear and logical that aggregate humanity will naturally aim towards the truth or even some shared point of equilibrium is a fantasy. People fail to understand and act on information that is plainly handed to them. Even the most advanced researchers can only understand causal mechanisms in asset pricing in unique situations or with many caveats. People focused on living their lives cannot automatically cut through noise to understand how the latest headlines will affect their obscurely chosen portfolio. Even the most normally accepted causal relationships are far from predictable. Constantly shifting macroeconomic factors mean that even someone with full access to relevant information can be consistently wrong in their interpretation of it. 

The manipulation of interest rates by the Federal Reserve bank makes it much more difficult for people to accurately price any asset. Heterogenous capital is bought based on assumptions that only hold up as long as the interest rate does. The interest rate being determined in some way outside of the normal logic of the market makes it very possible for asset prices to be wrong in countless ways. If interest rates happen to correlate with business cycles in a specific industry that leads to an increase of some capital purchases and a decrease in others, the cost of producing the outputs tied to those forms of capital will be distorted, and the price of those items will reflect interest rate realities rather than the counterfactual without artificial interest rates. Additionally, uncertainty about whether and how bank runs will be supported adds in an extra layer of distortion that makes it easy for more situations like the 2008 crisis to occur. If the Federal Reserve system was just a regular bank, they would not distort prices in the same way as they would bear real risk, and their interest rate choices would have consequences. While they wouldn’t be able to set interest rates as they do today, interest rates could naturally emerge and some large banks could for both self-interested and altruistic reasons step in to serve as a lender of last resort to smaller banks. J.P. Morgan did this in 1907, and we have no evidence that it would not have continued to happen if the Federal Reserve was not created.