by EconMatters, EconMatters.com
The Merriam-Webster definition for Market is the following:
- A meeting together of people for the purpose of trade by private purchase and sale and usually not by auction
- The people assembled at such a meeting. This just gives a starting point for this important discussion given the philosophical crossroads that financial markets are facing in today’s evolution of economic theory with regard to social and governmental policy decisions juxtaposed against the backdrop of the underlying nature of basic financial principles.
The past week saw the Chinese government take drastic measures to keep their financial market from falling further, the market has become as artificial as can be envisioned with sellers facing outright arrest for their actions.
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This really has brought to culmination the ever-trending debate of what role central banks, governments and centralized control have for financial markets. And what is the very nature of markets in general, what is their purpose, their structure, and ultimate sustainability going forward as entities.
Slippery Slope of Market Evolution
The US Central Bank has influenced market prices by lowering interest rates to zero, flooding the financial markets with massive liquidity, and outright asset purchases like treasury bonds. Japan has gone one step further in addition to buying bonds has expanded their Central Bank purchases to other financial assets like equity indexes. Many Central Banks like for example the Swiss National Bank holds shares in US equities like Apple Inc., Exxon Mobil Corp. and Johnson & Johnson to name a few of their holdings.
The Role of Central Planning
China which has long been a centrally planned government structure for economic initiatives who was trying to implement more free market reforms recently has reverted back to its fundamental nature and strategies and tried to completely control its stock market. Basically taking over every aspect of the market, forcing firms to buy stocks, closing stocks from trading, and arresting parties who wish to sell assets in the financial market.
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The best face to put on this behavior is that panic and irrational selling has taken over the market, and that the Chinese government is just putting in a giant trading curb in the market to give participants a chance to recover, take a deep breath, and reflect more rationally on the market. The other take on these measures in that they only make things worse, and in a sense have completely broken the market, it no longer exists.
Social Engineering Outcomes & Financial Markets
But the Chinese example is just the latest and final culmination in my mind of the slippery slope of governmental and central bank intervention in financial markets. The rub is this if central banks and governments view financial markets as Wealth Creation and Social Policy Initiatives, as Bernanke himself seemed to imply with his comments on the Russell 2000 during his tenure at the helm of the Federal Reserve, then the culmination of this rabbit hole journey is that central banks and governments have to intervene forever. A consistent forever, i.e., markets have to go up at a right angle forever, every year has to be higher than the previous year. If this is modern market theory than you have to commit forever, there is no stop and start commitment! It is like debt monetization theory and utilizing inflation to monetize an ever increasing debt over time by expanding the money supply.
If markets are no longer vehicles for price discovery, valuation metrics for business prospects and growth projections, or capital allocation vehicles reflecting sound business decisions by management; but rather proxy vehicles and conduits for Social Wealth Creation Policies then is doesn’t really matter if Enron is solvent or not, or a Chinese construction company is bankrupt as long as the government can make these shares appreciate each year in perpetuity. In other words to be a forever appreciating asset, and not a valuation or price discovery mechanism.
Therefore, two questions emerge can central banks and governments stomach or sustain this kind of commitment forever for financial markets, and will it work even if they do? And probably more importantly is this the best outcome for financial markets, i.e., would markets and financial markets in general and the overall economy be better off as a result of a different approach by central banks and government authorities over the long run?
These are some of the questions that all central banks and governmental policy leaders need to think hard about right now given the trend that has been emerging lately with policy decisions in regards to financial markets.
Call it whatever you want, but it isn’t a market!
My belief is that markets are markets for a reason, whether they are financial markets, the oil market, the housing market, the local farmer’s market or the illegal drug market, that fundamental economic and financial principles of price discovery and valuation metrics determining ultimate value lie beneath what it means to actually constitute a market.
What we have today are not markets, you can call a financial market a market, but they are no longer actually markets in the traditional sense of what it means to be a market. It is also my belief that ultimately the underlying financial and economic principles of market behavior and forces will prevail over central bank and governmental interventions. In the end it is just a matter of time! Markets can be influenced for a while, they can even be changed, but ultimately the core essence of what it means to be a market reasserts itself at often the least opportune moment in time.
Ultimately the assets in a marketplace represent valuation instruments, price discovery vehicles over time, and any approach that tries to circumvent this process is doomed to fail over the long haul as witnessed by how many companies no longer exist on a global basis over the last 50 years. Financial Markets are not socially engineering mechanisms for wealth creation strategies by central banks or governments, they are price discovery and valuation vehicles that are ultimately beholden to the underlying laws of economics and finance. So again I ask what does it mean to be a Market?
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