As many of you know, Hugh Hewitt has been on holiday for the past several days. His guest host today (or at least for this first segment) is someone named Jerry-something; I didn't catch the name, and I'm not familiar with him. But he raised an interesting question... one that he seemed incapable of answering, alas, for the answer seems pretty clear to me.

He asks the standard question about Iraq: "are we winning?" But he is drawn to the negative response, no we're not, by an interesting line of reasoning: he notes that oil hit a high today, and he deduces (rather, he surmises) that international investors are beginning to be convinced that we're losing and are going to lose. And as he points out, "markets are usually right."

But that facile pronouncement at the end is insufficient; it requires deeper thought: why are markets usually right? And under what conditions can they be egregiously wrong? Alas, many capitalists (such as myself) have such a kneejerk love of markets that we are occasionally led to attribute godlike powers of perception to them.

Markets normally work because of thousands, hundreds of thousands, or tens of millions of consumers who all have their own information sources; and because with that many different people arriving at different conclusions, each correcting as he sees his competitor doing better at this or that, you end up with a massive biological parallel processor with a positive-feedback loop: such a processor is far superior to any sort of top-down heuristic, or set of rules, where a single bad rule can ruin the entire chain of reasoning.

In a market, individuals make dreadful mistakes all the time; but rather than deflect the entire market down the wrong path -- as might happen if, say, the commanding officer in a battle made a dreadful mistake guessing where the enemy was -- the market usually absorbs the mistake: for every person who makes a mistake, there is another who exploits his superior perception, and the loss of the first is balanced by the gain of the second. In aggregate, those prone to mistakes are weeded out (they go bust), while the unusually perceptive become richer and more powerful. Eventually, the market itself, as a mass, moves... slowly, but usually in the correct direction to increase net wealth.

Yet not always. And the way I phrased it above, you can probably see the weak point. It's right here: "consumers who all have their own information sources."

The stock-market crash of 1929 is a good example of how the system fails. I am not an economist, and I hope I'm not completely misunderstanding this; but my impression is that a flood of people had gotten into stock speculation who had never invested money in the market before. They were buying on margin; this isn't necessarily bad, if you know what you're doing; but it's risky, and they had no idea how to calculate the risk. They put too much on the margin, and they invested in stock based not upon real financial information but upon emotional reactions -- because they had no access to accurate financial information, mostly because they had no idea where to look for it and couldn't understand it anyway.

I suspect much of the same was behind the "dot-com" boom and crash during the Clinton administration: lots of people getting into the market, being unaware of even the most basic financial information (such as the ratio of stock price to corporate earnings).

Anybody of at least average intelligence can evaluate a laundry soap or a breakfast cereal and come away with a pretty good understanding of how well it "works" -- cleans or tastes -- and how much it costs compared to competing products. This is near perfect consumer information. But some products (computer hardware and software, for example) require a much great degree of sophistication to evaluate and cannot be so easily priced by the consumer. In an atmosphere of imperfect information, consumers grab for any datum they can get... usually asking their equally unknowing friends (which measures ubiquity) or reading reviews -- which measures the amount of money companies are willing to pay for fake "reviews" in trade magazines, since the average consumer wouldn't know a real trade magazine and a reliable reviewer from a paid hack in a magazine that makes much of its money from advertisements.

Markets fail to reflect or predict reality when the consumers have little access to accurate information, or worse, great access to authoritative-sounding fraudulent information.

And that is precisely what is happening with the market's perception of the progress of the Iraq war. Combat is not a financial measure; the only hint that oil traders have about the war is through the news, which in this case means the MSM. To be perhaps excessively blunt, all they know is what they read in the papers.

Individual investors cannot go to Iraq and "see for themselves," as an ordinary consumer can taste a breakfast cereal or try out a computer application: the war zone is too dangerous, they're denied entry to the most interesting areas (where the fighting is fiercest, for example), and much of what is happening would be invisible anyway on a brief trip. One would need to be stationed in Iraq for months or even a year or two to have a good idea what is happening. It's likely that the average Marine Corps staff sergeant on his second or third tour knows a hell of a lot more about the war progress than the most astute oil investor based in Paris or even Abu Dhabi; but the Marine doesn't bid on sweet light crude.

The bias of the American MSM against the Iraq war is, believe it or not, almost nil compared to the bias of the news services in most other countries; so too the willingness to print nightmarish fantasy instead of observed fact. To read the news in France, Japan, or even England is to get the impression not that we're losing, but that we've already lost, that we're staggering and ready to drop, and that we've nearly been driven entirely out of the Middle East.

Here's a depressing little experiment you can try; if you do, please comment with the results. Seek out friends of yours who don't follow the news closely -- not bloggers or blog readers, obviously, unless they confine their reading to dKos or Juan Cole (sorry, I couldn't resist!) -- and ask them the following question. Ask with a neutral voice and no facial expression, as if you were a professional pollster (say, maybe someone should commission an actual professional poll using this question):

Comparing the war in Iraq to the war in Vietnam, would you say that American deaths in Iraq have been:

a) Significantly more than in Vietnam
b) Somewhat more than in Vietnam
c) About the same as in Vietnam
d) Somewhat less than in Vietnam
e) Significantly less than in Vietnam

The correct answer, any way you choose to measure it (per month, as a percent of the force, &c), is (e), of course. But I suspect that most people who get all of their news from the MSM would answer (b) or (c), because that's the way the networks and most of the major dailies portray it. And of course, it's even worse in foreign countries; I wonder how many consumers of Agence France-Presse or al-Jazeera (which likely includes many oil investors in Europe and the Middle East) would answer (a), the reality-free choice?

This sets up exactly the kind of market failure seen in stock-market crashes: little access to accurate information, great access to fraudulent information. And for that very reason, the spot oil market is completely incapable of properly analyzing progress in the Iraq war.

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