Don't Let the Paper Dragon Frighten You

The Mail on Sunday (London, England), August 14, 2011 | Go to article overview

Don't Let the Paper Dragon Frighten You


Byline: William REES-MOGG

One of the most interesting of the late-19th Century political economists was the Italian Vilfredo Pareto, who in 1897 made an important contribution to the study of economic cycles.

He argued that 'manifestations of human activity cannot be represented as a continual progression; they generally assume the form of an undulating curve.

'Amongst other things it should be noted that Man rarely stops at the appropriate point; he always tends to over-react. He passes from hope to fear, from an excess of trust to an excess of suspicion; he is exalted by success and downcast by failure.' That is what the Stock Exchange is like; for that matter, it is what war is like.

This insight has led to a whole school of investment theory - contrarian.

Such investors believe there will always be cyclical movements in the global stock markets, and those movements will be exaggerated.

Therefore, the objective of contrarian investors is to walk against the crowd, to buy when everyone else is selling and sell when everyone else is buying. As a system, it does not always work, but it probably works better than any other.

Maynard Keynes, the great Cambridge economist of the Thirties, was a successful speculator, though on one occasion in his youth he was bailed out by his father, who was also a Cambridge economist. As a speculator Keynes was a contrarian with confidence in his own judgment.

Another leading economist of the Thirties, Gottfried Haberler, who was an authority in his time, noticed how often Keynes, in his 1936 book General Theory Of Employment, Interest And Money, fastened on the importance of expectation as an influence on the business cycle.

Haberler commented on the theory that 'almost every concept is defined in terms of expectations'.

If one looks around our modern world, economic expectations are extremely depressed, but that does not mean they are right.

This has been a period of nasty shocks, including the riots in England last week and the reduction of America's credit rating from triple-A to AA+ by Standard & Poor's. Two nails have been added to the coffin of world finance.

Are we facing some final financial apocalypse, or is this the darkness which, in human affairs, often comes before the dawn? There are reasons to think that the market has been oversold, that this accumulation of social and financial defeats has led to an over-reaction.

Last Tuesday, Wall Street had an excellent morning, though in the afternoon the American markets suffered a downturn, despite good news from the Federal Reserve. Meanwhile, the market for gold is being tipped to reach a record level of [pounds sterling]1,547 ($2,500) an ounce. …

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