Cow, saw dust, real estate and milk price

And for some reason the price of milk was increasing. A curious economist spoke to a farmer and asked why this was happening. The farmer said that the cost of his inputs has gone up, just as the price of sawdust has doubled.

Now what does the price of milk have to do with the doubling of sawdust? Dairy farmers used sawdust to put their cows to bed comfortably. As Steven E. Rhodes writes in The Economist’s View of the World and the Quest for Well Being: “[Cows] produced more milk when they were off their feet more often.” Therefore, the more comfortably a cow is in bed, the more milk it produces.

But the price of sawdust had gone up and dairy farmers were not using their cows to bed comfortably as they used to. So, why did the price of sawdust rise? As Rhodes writes, “The reason for the increase in the price of sawdust was a sharp drop in the production of new housing. Since there was less construction of new homes, there was less sawdust.”

This raises the question, why was the construction of new houses stopped? With the real estate bubble bursting, demand for new homes had collapsed leading to speculation. With the demand for new homes falling, the demand for and use of wood for the construction of new homes was reduced.

Low demand for wood resulted in less sawdust production. This pushed up the price of sawdust, causing dairy farmers to use less sawdust and cows were being bedded less comfortably and produced less milk in the process, raising the price.

The big point of this example is that economic trends can be complicated by a number of underlying causes, which are not always easy to understand. Take the example of the recent fall in the price of shares. The simplest reason on offer is that the United States Federal Reserve is planning to end its easing currency policy and begin raising interest rates. In such a situation, investors are exiting the stock market.

But there are other reasons to play as well. High inflation is an important reason in India and around the world. This means that the company’s earnings may not grow at the same pace as it has been in the recent past. In addition, oil prices are rising. And there is a threat of war in Ukraine.

Does this mean that stock prices will continue to fall? There is no definite answer here. While the Federal Reserve is ending its easy currency policy, China is following one. At the same time, the question now being asked is what would happen if the end of the easing currency policy by the Federal Reserve triggers a recession in the US and other parts of the world. Or what happens if a more deadly form of the covid virus emerges? Will this lead the Federal Reserve and other central banks going back to an easier currency policy and causing stock prices to rise again?

In that sense, one is playing probabilities here. The likelihood of stock prices to rise significantly again in 2022 is slim, yet, it cannot be said with complete certainty.

Of course, there are stock market experts out there who have made a career out of saying things with absolute certainty. And people love this trust, because experts are saying what people want to hear.

As now, many retail investors want to point out that the decline is temporary and will end soon. The trouble is, given the huge number of interrelated factors at play, no one really knows, but that doesn’t stop experts from being reassured and telling people what they want to hear.

As Dan Gardner writes in Future Babel, “Feeling good about a decision is a prerequisite to acting on it… [Overconfidence] encourages people to take action and makes them more resilient in the face of setbacks.” Now just because you’re making decisions and feeling resilient based on your own or someone else’s overconfidence, its Doesn’t mean it will be proven correct. That’s the long and the short of it.

Vivek Kaul is the author of Bad Money.