Guesswork

In some sense, all of history’s progress from lives that were nasty, brutish and short to today’s splendiferous buffet of iPhones, nine-month courses of physical therapy, and year-round fresh broccoli can be summed up in three words: gains from trade. We live better than a tribe of chimpanzees roaming through the primordial forest because we specialize and then exchange the fruits of our skills with each other. Trade, as the ecoomists say, increases the size of the economic pie to be divided between us.

via Ask the editors: What difference does it make to the recession if Citibank and Bank of America fail? – Megan McArdle.

With these words, Megan starts an unusual article that expresses economic concepts in an unusual way. She ends up writing about the importance of guesswork.

This is a different way of thinking about the world in general and economics in particular, but it is perfectly valid. We all make guesses about the future. Sometimes this is the very near future (should I take an umbrella?) and sometimes the distant future (should I invest in my 401K?). What happens to us individually and collectively is partially a result of the quality of our guesses.

Megan’s point is that when many people guess wrong, we end up with an economic mess like we have today. That’s the most simple and direct way to think about it. Too many people guessed that the price of housing would continue to skyrocket, despite the fact that builders were expanding housing at record rates. In retrospect, it looks like a stupid guess. Stupid or not, it was a widespread guess by borrowers, lenders, government agencies, insurance companies, pension funds, and others. And here we are.

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