The Markets Are Efficient .. But Only This Time

We've just gone through a period where we were told emphatically that the recent financial crisis proved without a shadow of a doubt that the efficient market hypothesis is bupkis. Now critics of that idea are saying that the market is indeed efficient and we need more stimulus spending.

Here's how the argument goes: if the bond market fears the direction the U.S. is headed – long-term unemployment, high budget deficits, unsustainable social programs – then it would be putting its money where its mouth is. It would be much more costly for the U.S. to borrow. But what we're seeing now from the bond market, this argument continues, is something completely different. That market is buying U.S. bonds hand over fist, efficiently telling us that – well, I don't know what that's telling us. But no matter. We can borrow really cheaply. That market is saying we need more stimulus spending!

See. Don't you get it? Before the financial crisis, it was really easy for the U.S. to borrow, so the market was inefficient. But now that it's really easy for the U.S. to borrow, it's efficient.

OK, I'll admit, I'm really confused:

The volatility in the stock market has also pushed some investors to allocate more of their funds to cash and cash-equivalents like Treasury securities. In addition, overseas demand for federal securities has been high because U.S. bonds are still considered the safest haven in the wake of concerns about the fiscal stability of Greece, Spain and other countries.

But all of this also proves the point about the former vigilantes becoming deficit cheerleaders. Banks and investors would look for other places to park their cash if federal bonds were considered dangerous or likely to become illiquid because of borrowing concerns. That's obviously not the case.

So, depending on the day, critics tell us either that the market is being very clear and efficient (go stimulus spending, go!) or the market is sending mixed signals and being inefficient (go stimulus spending, go!).

They seem to want it both ways, don't they?