Fischer Black Redux: The Impossible Circularity of a Metaphysical Argument


In the last piece on Fischer Black we saw how he created, in his own mind, an entity called “noise” which, for him, explained all the shortcomings of the world. But such raises an important question: shortcomings in the face of what? The answer, of course, is a perfect equilibrium world where everything that was once shrouded in Darkness is brought into the Light. In short, a vision of a world without Sin; a world before the Fall.

But Black, it would seem, thought himself not so naive. His colleagues, he correctly thought, were fooled that they were in the process of returning to the Garden of Eden — or, perhaps, they were already there — but Black considered himself more wily. Black was, it would seem, more of a Manichean. In this Black thought that Light itself — Goodness, Truth, Signal, whatever else we want to call it — relied for its existence on Darkness — Sin, Falsehood, Noise.

It is this simple claim, I think, this slight difference of metaphysics that gives Black his undeserved status among economists today as being an “interesting” thinker. Where the Efficient Market Hypothesis crowd claimed that all was always already right with the world, Black said “No, there is necessarily Darkness in the world, there is necessarily Noise, it is upon this that Light and Signal rely”. Here is Black himself in his typical hackneyed prose style:

Noise makes financial markets possible, but also makes them imperfect. If there is no noise trading, there will be very little trading in individual assets. People will hold individual assets, directly or indirectly, but they will rarely trade them.

The implication, of course, being that if assets are not traded then there are no markets. And if assets aren’t traded unless there is “noise” then there are no markets without noise.

It is this simple, and rather obvious point — one already articulated by Stiglitz and Grossman as far back as six years before Black did — that makes Black’s insights seem edgy and interesting to his colleagues. As we will see this has very little implications for the view of the world held by Black or his followers, one which remains hopelessly devoted to believing that the Promised Land is about to appear at any moment. But before we look at this let us reflect briefly on the culture that produces these sorts of theories.

As already hinted at Black’s remarks, which were made when he was president of the American Finance Association, were considered somewhat shocking by his colleagues. What’s more, Black was apparently marginalised to some degree by the economists and considered a “finance guy” with funny ideas. And yet his ideas are so mainstream. They are so lacking in shock value and, on examination, appear so crude and overtly metaphysical. Well, I think this tells us something about the kind of culture that bred these financial theories in the first place.

It is a culture that literally worships market equilibrium. I mean this literally. Market equilibrium is considered among these not simply an a priori given — an assumption that is toxic enough — but something that can only be questioned by generating an enormous amount of controversy (as has not just Black’s work, but also Stiglitz’s). And yet on its face market equilibrium is such a stupid and unrealistic assumption with which to approach the real world. Well that, I would argue, is precisely why a taboo must be placed over questioning it by these people. Because deep down they know that if we had a frank conversation about the assumption they would lose the argument, so a Holy Mist has to be thrown up together with an oppressive culture of devotion and non-questioning.

But back to Black. What does he conclude from his little foray into what he clearly considers heterodoxy. Well, he makes the claim that the market is, despite having a necessary noise-component, nevertheless moving toward some sort of quasi-equilibrium perfection and it is this finding of the Promised Land that will prove him correct. I will let Black lay out his outlandish and childish vision in his own words (and I use the word “vision” here in its mystical sense):

In the end my response to the skepticism of others is to make a prediction: someday, these conclusions will be widely accepted. The influence of noise traders will become apparent.

But now, Black does not mean we will enter a world of instability or turmoil. He continues…

Conventional monetary and fiscal policies will be seen as ineffective. Changes in exchange rates will come to provoke no more comment than changes in the real price of an airline ticket.

What a farce, of course. But this is precisely what his audience wanted to hear. They wanted Black to act like a Seer bringing with him a metaphysical vision. This is literally what goes on at these types of conferences. These are the people that those in the financial markets reference everyday and look to for Salvation. But what happens if Black’s vision does not come to pass? Is he going to organise that everyone drink the Kool Aid if his Promised Land fails to arrive?

Nothing so extreme, because Black finds a way to hedge his vision in the most tautological manner imaginable:

If my conclusions are not accepted, I will blame it on noise.

He says this half-joking, of course, but if you follow the logic of his paper closely you will realise that he is at the same time completely serious. Black quite literally Knows that he is right. As if he has received a vision from some entity outside this world. And that, I contend, is what a great deal of modern financial theory is really all about.


About pilkingtonphil

Philip Pilkington is a macroeconomist and investment professional. Writing about all things macro and investment. Views my own.You can follow him on Twitter at @philippilk.
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