The Importance of Epistemic Rationality

Epistemic Rationality is the ability to gain and hold accurate beliefs about the world around us. It is crucial for being able to make informed decisions that have as high a probability as possible of improving one’s situation.

The importance of epistemic rationality can be glimpsed in these few paras from an investment report written by Doug Noland

Back in 2000, I titled a presentation (and CBB) “How Could Irving Fisher Have Been So Wrong?” From Wikipedia: “The stock market crash of 1929 and the subsequent Great Depression cost Fisher much of his personal wealth and academic reputation. He famously predicted, three days before the crash, ‘Stock prices have reached what looks like a permanently high plateau.’ Irving Fisher stated on October 21 that the market was ‘only shaking out of the lunatic fringe’ and went on to explain why he felt the prices still had not caught up with their real value and should go much higher.”

Fisher, one of America’s most accomplished economists, was in 1929 operating with a deeply flawed analytical framework. And for years leading up to the crash the optimists had been repeatedly emboldened, as a booming stock market confirmed their view of the world. Fisher and the world were then completely blindsided. Their views of how the economy, the securities markets, policymaking and Credit interacted were completely erroneous. I expect some resolution to competing analytical frameworks will be a key Issue 2016.

Today’s conventional view holds that the underlying fundamentals supporting the U.S. economy are healthy. In general, fundamentals drive the markets. Finance is sound. China, commodities and a downshift in global growth are temporary setbacks that ensure ongoing ultra-loose monetary policies. U.S. markets will soon look beyond negatives, as focus returns to long-term favorable prospects for growth, corporate profits and inflation.

An opposing analytical framework, one to which I subscribe, is focused foremost on finance – in particular the system of securities-based Credit and securities markets that over the past thirty years rose to world dominance. Regrettably, this “system” is deeply flawed and today acutely unstable. In short, global “money” and Credit are structurally unsound. In general, and especially late in this era, market-based finance drives economies. Unprecedented central bank monetization and market manipulation have inflated securities markets along with underlying fundamentals (corporate cash flows/profits, incomes, household perceived wealth and GDP).

Noland may, of course, be wrong. His analytical framework – his mental model, or mind-set – may be just as wrong as Fisher’s. But the only test of an analytical framework, and the best test, is its ability to forecast developments.

Fisher’s analytical framework was clearly wrong, as a result of deficiencies in his epistemic rationality. As a result, he had a mistaken view of the world, and this view cost him, and possibly others, a lot of money when the markets crashed.

Noland is, like Fisher, betting his all on his analytical framework being correct, and thus on his ability to foresee how events will unfold.

I can’t tell you how much I enjoy watching people pit their analytical frameworks against each other, and how it cheers me to see people backing themselves and their beliefs in what is, compared to warfare and grand strategy, the relatively harmless arena of finance. Because the high stakes encourage them to take epistemic rationality seriously.

For a high-level, philosophical-scientific examination of the physical basis of epistemic rationality, please watch this TED talk.


About Stebbing Heuer

A person interested in exploring human perception, reasoning, judgement and deciding, and in promoting clear, effective thinking and the making of good decisions.
This entry was posted in Epistemic Rationality, Good Thinking, Hypotheses, Insights, intuition and judgment, Mind-sets and Logic-Bubbles, Reasoning, Sound Reasoning. Bookmark the permalink.

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