Markets, metaphors, and mania

Abstract

Financial markets have sufficient power over the real economy to enable them to expand their profitable activities and extract compensation for their services from the real economy – not necessarily commensurate with the economic value of those services – without the real economy being aware of it being done. Given that markets have this ability to manipulate the economy to their advantage, there is no guarantee that the equilibrium size of the market – meaning that there is no incentive for firms to either enter or exit – is the equilibrium size of the market for the most efficient operation of the real economy. Financial markets are quite literally parasites in every biological sense of the word, and more widespread recognition of this apt metaphor might lead to more effective public policy decision-making. Market insiders are not selfless public servants but are looking out for their own self-interest. There is a market for financial services that itself has few, if any, characteristics of a free market.

Keywords:

• metaphor
• parasite
• lubricant
• catalyst
• deregulation
• volatility

Notes

1. McGee (2010) uses this as a chapter title.

2. The catalyst might, however, be physically changed over the longer term; solid particles of catalyst can grow smaller (attrition) or larger (agglomeration). Such changes in structure slowly degrade the effectiveness of the catalyst, and eventually it must be replaced or reconditioned (Perry and Chilton 1973; Parker 1994).

3. This is easier to do, the more outside buyers and sellers – less informed or less nimble than the intermediaries – who can be attracted to the market.

4. As much as 97% of foreign exchange transactions are wholesale transactions, that is, transactions within the market itself and not with retail customers who have one currency and need another to make a purchase of something other than another currency itself (Bank for International Settlements 2010).

5. Originally, hedge funds did hedge their speculative positions against overall market movements, but the name remained after this strategy was largely abandoned (Mallaby 2010).

6. It is possible, though, that half the speculators (value-weighted) are net losers and eventually leave the market, with the overall cadre of speculators kept at full strength by hopeful replacements.

7. Federal Reserve Chairman and Ayn Rand disciple Allan Greenspan notoriously failed to believe that financial market participants would risk their reputations in questionable practices until it was indisputable that so many had (Hirsh 2010; Taibbi 2010).

8. Admittedly, it can be difficult to distinguish pure proprietary trading from trading in conjunction with customer transactions.  But there is indeed pure proprietary trading, and the purchase of naked credit default swaps – thereby insuring against an event in which one has no prior interest – is but one example.