What should everyone know about economics?

Answer by Jeremy Arnold:

10 Common Economic Myths Revisited

Some great answers already given by Balaji Viswanathan and Roshan Cariappa. But, as they focused more on the academic fundamentals, I thought I'd have some fun by attacking some common myths and misconceptions.

So, here we go:

Myth #1: Central banks are the problem.

Without demand, all a central bank can do is "push on a string". And demand itself is simply people wanting things. If the broader part of a population (or its government) is willingly to recklessly pursue things that they can't afford, you have a cultural problem, not an economic one. Focusing on the supplier doesn't tend to accomplish much. You have to deal with the root: the addiction itself.

Myth #2: Debt is always bad.

As the old saying goes, "it's the dose that makes the poison". Debt is necessary for a healthy economy. It's just a question of proportion. This holds true on both the commercial and household side. If everyone is saving and no one is borrowing, you're going to have some serious growth problems. "Know your limits and play within them." But we need to play up to those limits, if playing prudently.

Myth #3: Superpower status comes from good policy.

History confirms that past superpowers reached their zenith through one or more of the following means: luck, slavery, theft, war, fraud, or tribute. Skill and efficiency can definitely create significant advantages, but not at the scale that was seen in the "glory days" of empires and hegemons. No country that plays by modern rules will ever ascend those heights again.

Myth #4: Western governments can just print spending money.

A government can't just call up their central bank and get a boatload of money printed up to line the public coffers. Central banks can purchase government bonds, but must do so through the secondary market. Central banks can also create money in the sense of increasing the reserves of the banks in their network, but it's up to those banks to multiply that money through fractional reserve banking. When they do, that benefits the economy on a whole, not the government itself.

* I'm only speaking to the West. Governments in a limited number of other places that have no arms-length central banks can print-and-spend (also true for the UK, in a limited sense).

Myth #5: Fractional reserve banking is bad, and unnecessary.

As with debt, this is a question of proportion. A reserve ratio of 3% is probably a terrible idea. But the basic concept of how the system works is simply inarguably positive. There is no credible alternative. Here's why: if money doesn't multiply, modern banks don't exist. (It would leave them without the ability to collect interest or make profits.)
 

Myth #6: The stock-market is beatable.

While this is more finance than economics, I thought it was worth including. The idea of "beating the market" is used in a very imprecise way by a lot of casual investors. People sometimes forget the simple fact that the whole point of an "exchange" is that a deal is being made between two (or more) parties, not with the market itself. For me to buy a stock, the current holder has to be willing to sell it at the quoted price. How convinced am I that I know more about the proper value of the stock than they do?

* The only way to truly "beat a market" would be to short an index fund. I get that some folks use the expression to mean that their custom picks outperform a given index fund, but it's a silly way of saying it.

Myth#7: Rich companies pay the most taxes.

Who writes the tax codes? Politicians. And their favour is intensely courted by lobbying firms that represent large corporations. The end result is a lot of deductions, discounts, and exemptions for the largest players. In some countries, this is also true on a personal level. As Warren Buffet famously shared, his marginal tax rate is less than his secretary's. The truth is that the heaviest proportional burden is always borne by the meat of the middle-class.

Myth #8: Academic economics is all about science.

Math is a language that allows us to describe the functions of a given system. Science is the investigation into the dynamics of that system. The truth is that there are a good number of economists out there who really don't understand much about the practical world that their models describe. They're just math wizards. As such, their work is of limited utility to casual readers.

* No, not all economists are guilty of this. It's hard to say what percentage are. Many are brilliant in the practical sphere. But I think the broad point is still fair. How can a PhD-level expert understand things like Black-Scholes and derivative volatility models and yet not understand the basic principles of systemic risk and over-leveraging? The written record proves that a whole lot of them didn't see 2008 coming.

Myths #9: Bubbles are sure opportunities for profit.

Just because you spotted an error in pricing, doesn't mean that you're going to profit off of it. Naked emperors can be surprisingly resilient when the trumpet-blower isn't a market-mover like Mr. Buffet. Bubbles tend to burst at arbitrary speeds. Take a stock like Amazon for example. It's currently valued at $152bn in market cap. When compared to revenues, this is quite reasonable. Except that stock prices have no correlation to revenues — they need to be tied to the expectation of future profits. Amazon has no profits, and its CEO has quite literally built his business model around the premise of making no profits. You can short their stock all you want in protest, but as Keynes wisely observed, "the market can stay irrational longer than you can stay solvent."

* Yes, I know that they expect to make profits in a day to come, once they've monopolized their key markets. Which is fine, except that the world has changed and that day isn't coming. (At least, never to the tune of repaying $152bn in stock value.)

Myth #10: Outsourcing makes rich countries poorer.

Getting more done with less means more overall wealth. That isn't really up for debate. The problem is that this model demands that displaced workers be migrated to higher-value jobs. That isn't happening. But that's not a flaw in the economic theory. It just reflects a broken sociopolitical system. 

Note: None of my points are really controversial. If they sound like it, it's largely because of the fuzzy economic narratives present in a lot of mass-media sources. I'd be happy to have my reasoning challenged in the comments. If you'll be respectful, I'll be patient (and willing to be wrong).

Note 2: For those looking for a more detailed understanding of the technical bits, see the comment string with Steven Ford below.

What should everyone know about economics?

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What should everyone know about economics?

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