Why Common Wisdom is Wrong

It is implicitly assumed in a number of the articles posted here that the common view is wrong. That is why the blog exists: To find uncommon knowledge about the markets and uncover it. Take any popular, and especially political, belief about the economy, and I contend that the odds are highly likely that it is incorrect. Since that statement implies that you and I will be among a few voices speaking into the wind, it's worth examining the basis for our contrary perspective.

For background I will be using Stumbling on Happiness by Daniel Gilbert, a professor of psychology at Harvard University. Although the theme of this book is understanding happiness, it necessarily draws in many conclusions from the academic literature on psychology, much of which is, of course, based on hundreds or thousands of careful experiments on genuine human beings.

The first evidence is that people are inaccurate observers of themselves. Their ego-defense mechanisms create information that isn't true, by selecting carefully new information that is designed to support a pre-existing thesis that they are above average. This belief, that they are above average, is supported by having friends who aren't as skilled by comparison. Gilbert writes:

"If we can't find people who are doing more poorly than we are, we go out and create them. Volunteers in one study took a test and then were given an opportunity to provide hints that would either help or hinder a friend's performance on the same test. Although volunteers helped their friends when the test was described as a game, they actively hindered their friends when the test was described as an important measure of intellectual ability."

If you don't believe Gilbert, get his references list and look at the studies he is citing. For example, there is Some effects of task relevance and friendship on helping: You don't always help the one you like. For a broader survey, take a looks at Selective Exposure by Freedman and Sears. Or you can go to Lake Woebegone, where all of the children are above average.

Of course, this just scratches the surface of all the things people do to their own belief systems. Rationalization, scape-goating, selective exposure and many other subtle effects do enormous damage to the ability of people to see social and economic worlds accurately.

Even the Federal Reserve and its celebrated theoreticians may be reality-challenged. Friday, Caroline Baum wrote "Fed Theoreticians Need Some Real-World Feedback" for Bloomberg, citing an informal but enlightening survey she had done that proved that people have very strange and inaccurate perceptions of inflation ("Nobel Laureate Bob Lucas, Meet Randa the Psychic: Caroline Baum"). Unfortunately for the Fed, they have the double problem of measuring the inflation expectations of the market, which is, perhaps hopelessly wrong, at least among people asked for an opinion on the street.

How do address this, as investors trying to discover reality? Do we accept the results of Baum's survey at face value, that a woman business owner of 20 years believes that inflation is 20 percent? Perhaps some skepticism is in order. The response could be exaggerated because the woman recognizes that her response will be influential, and she is going for the dramatic lie to show her point. Perhaps she really believes that inflation is exactly at the government-measured level, but that prices of certain highly visible commodities have recently and only for a short time exhibited a 20 percent annual rate of inflation. That is, people may say crazy things to informal survey-takers, because the process of sampling their opinion distorts their communications, or gives them an incentive to distort. Perhaps they lie because it is suddenly in their interest to do so.

Or maybe lying is too strong a word. People have beliefs, and they stick to them. It takes an avalanche of new information to change their minds. The recent Nobel Prize in Chemistry was awarded to a Daniel Shechtman for his work in the discovery of quasicrystals, the same work that was ridiculed by colleagues for many years. Major advances in science regularly meet with disbelief and ridicule. The take up of plate tectonics theory in the geology community in the 1950s is frequently cited as an example of this phenomenon.

But back to this result that shows that people "help" their friends to be below average. Could this mean that:

• Political policy designed to help disadvantaged groups actually causes them to be at a permanent disadvantage, so that advocates of political change can retain their superior starting position?
• Institutional investors working in an office where they are graded by their performance tend to "un-help" their colleagues by giving them information that reduces their investment performance?
• Everything you read on Seeking Alpha is a clever misdirection?
• It is any mystery at all that the message boards on Yahoo! Finance contain very little of any utility?
• Sell-side research from the large securities brokers has zero value, especially considering the order in which clients are exposed to it?