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Bonds, Speculators—and Philosophers

Occam's Razor seems to be slicing through the financial blogosphere.

Joe Weisenthal wrote about it this morning. Perhaps, based on the time stamps of the posts, he was inspired by Felix Salmon—who had used the concept in a post about the alleged 'speculation' in eurozone debt.

Felix Salmon jumps off from an article in The New York Times about the 'fight' between financiers and central bankers.

Salmon basically argues the following: You can't blame speculative short selling for the drop in the price of an asset—if a better and simpler explanation for the selloff is that investors think that the assets they own are overvalued. Because in that scenario, rational investors are going to try to reduce their positions. Stat.

And prices will fall.

Salmon's argument is more nuanced, but that's the crux—and I think he is dead-on accurate.

He invokes Occam's Razor: "if everything going on in European bond markets can be explained without recourse to evil speculators then there’s no reason to talk about them at such great length or to demonize them—unless you’re some kind of politician."

The point of The Razor is this: The simplest explanation likely has the greatest probability of being correct. It's an enchanting notion—and I see why it captured both of their eyes.

For example, incompetence is usually the simpler—and, therefore, a better and more likely— explanation than conspiracy.

When you're at a bar with one of your buddies and he insists that someone 'stole' his worthless apartment keys at 3:00 in the morning, it's more likely that he drunkenly lost them—because it doesn't posit the existence of an irrational malefactor.

Be wary of elaborate explanations from politicians—especially if market forces and common sense are self-explanatory.

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