How electorates and markets change their minds

I spent election night 1994 shuttling between the Montgomery campaign headquarters of Jim Folsom Jr. and Fob James, the candidates for governor of Alabama that year. Incumbent Democrat Folsom was a decent if unimpressive man. Republican James, who had been the Democratic governor about a decade before, was a know-it-all-who-didn’t-really-know-anything jerk. James won, Folsom lost, and I was kind of sad about that.

Then I got in my car and began the drive back home to Birmingham. I switched the radio to AM to listen to election news, and began taking advantage of that wonderful property of AM in the middle of the night to listen to election news from all over the country. The story was similar on pretty every much station I tuned to. Democrats who had been in office for decades were being turned out everywhere.

My personal politics are all over the place, but I nonetheless found the news thrilling. The House of Representatives, in the hands of the same ossified party since the mid-1950s, had been given new bosses.

Last Tuesday night’s turnaround was less historic and dramatic, but I found it similarly exciting. I’m always very dubious of claims that election results represent “the will of the people,” given how conflicted and ill-defined and malleable that will tends to be. But every once in a while the electorate expresses in pretty clear terms its dissatisfaction with the way things are going. And therein lies the beauty of a functioning democracy — a nation can change course, can change its mind, without violence or other disruption.

Financial markets are capable of changing their minds, too. When they do it on a micro-level, differentiating between individual companies or securities (or even individual political candidates in something like the Iowa Electronic Markets), it’s a cleaner, more efficient process than an election. But when markets really need to change course, when investors’ expectations about the future are suddenly dashed in an across-the-board way (like in the U.S. in 1929-1931, or Asia in the late 1990s) the result can be a really big mess. There are a few things, it turns out, that politicians actually handle better than free markets do.

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