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Sunday, August 12, 2012

Finding value: Correlation vs Causation

There's a great scene in the Steve Martin movie "All of Me" where an Indian Holy Man is staying in a modern hotel and he flushes a toilet for the first time and the telephone rings.  He flushes again and the phone rings again.   So he thinks that flushing the toilet makes the phone ring.

Unfortunately, this gag describes the state of the human reasoning mechanism throughout much of modern human history.

To think that flushing the toilet makes the phone ring because these things happened together - they were correlated - at one time, forms the basis of almost all political and economic argument today.

This is a great sight gag.  And it is no dumber than saying, for example, that because for 40 years stocks went up, they will always go up over time.

Or saying that when Reagan cut the top marginal tax rate in 1980 from 70 percent to 55 percent in a surplus economy and the number we use to describe GDP got bigger, the same thing will happen in 2012 if we cut the top rate from 30 to 25 in a deficit economy.

Or saying that because a certain chart pattern occurred in 2001 and a stock or commodity went up - the same chart pattern will produce the same result in 2012.

Or by saying that when a certain law was passed in 1933 - certain stocks went up, so the same stocks will go up if a similar law is reenacted in 2012.

Or saying because at object realized a certain price in a recent auction therefor that is the "fair market value" of the object.

Or saying because a certain junior gold stock X found x ounces in the ground and its stock price went up, therefor when a certain junior gold stock Y finds x ounces in the ground it stock price should go up.

Or saying because Paul Wolfowitz is Jewish, US foreign policy is deployed in the service of Israel.

And the culmination of this sloppy thinking results in arguments that suggest a desired result (i.e. "bring down the deficit") is the same as having a viable plan to bring about the desired result.

In other words: I speak a sentence in which a desired result occurs (the correlation), therefor I will bring this result about in physical reality.

Put this way, this assertion sounds incredibly stupid, yet it lies at the heart of 99% of political and economic argumentation.

How does this apply to you finding value in the real economy today?

If you can see the fallacy in this type of argumentation you can begin to analyze things for yourself, in stead of relying on "experts."

And, unfortunately, thinking for yourself is the only way to find value in the modern political economy.

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