JOIN USPrice discovery is a function of the levels of awareness and knowledge of market participants.
While debating a high frequency trader (HFT) recently, I encountered the familiar rationalisations that HFT contributes to liquidity and price discovery in markets. Assertions about liquidity are hard to justify after the “flash crash” of May 6, 2010, where the “faux liquidity” of HFT disappeared when needed and the traditional market-making obligations of the old specialists were absent.
Price discovery is a function of the levels of awareness and knowledge of market participants and the market places (physical and electronic) in which they trade. Clearly, HFT players contribute little and the “maker-taker” model they use together with today’s electronic markets distorts price discovery in additional ways through co-location and “latency” strategies (i.e., the speed of their computers), which are a form of “front running.”
In most worldwide markets today, price discovery is ignorant of planetary boundaries and the discoveries made by Nasa satellite Earth Systems showing how our home planet functions in relation to our sun’s daily shower of photons. Most markets and their participants do not understand that all life on earth is a function of this flow of photons and their capture by green plants through their technology of photosynthesis, which creates our human food supply.
Price discovery is a human activity dependent not only on our levels of knowledge but also on our cultural conditioning and herd behaviour – all better researched by psychologists (Daniel Kahneman), anthropologists (Sissela Bok), brain scientists (Bruce Lipton) and endocrinologists.
“Doubling down”
Indeed, many now study traders as a clinical population, showing how their behaviour is governed by their hormonal levels, as described by John Coates in his book The Hour Between Dog and Wolf (2012). Biologist Coates describes how over-leveraging and betting are governed by excessive testosterone and produces the familiar “doubling down” on risk such as that of Jon Corzine in the demise of MF Global. Coates shows how market drops then trigger panic when the hormone cortisol takes over and leaves the trader like a deer caught in headlights.
These hormonal processes cause diarrhoea and the rush to the bathrooms or vomiting. Scott Patterson, in his book Dark Pools, describes how high frequency traders drink less so as to reduce urination and some keep buckets beside their computer if needed for vomiting.
Trading, an age-old human activity, can become obsessive and an addiction akin to gambling. Price discovery by today’s traders in today’s global markets is clearly unreliable. Then, we must take into account the pervasiveness of externalities, for example the 500 billion dollars of subsidies to fossil fuels annually worldwide, as well as the thousands of other subsidies, loopholes and lack of regulation in most industrial sectors. All this further distorts prices.
Thus the assertions that economics is a science are clearly absurd, and the Nobel Committee’s acceptance of the Bank of Sweden’s Prize for economics “in Memory of Alfred Nobel” has now been repudiated by lawyer Peter Nobel and other Nobel family members. Not only on these behavioural grounds is economics deficient but also on its pretensions of mathematical precision and its many illusions due to abstraction.
As I pointed out in The Politics of the Solar Age (1981, 1988), compound interest is a fantasy of mathematics enforced on society by powerful financial interests as in “austerity” policies. Neither does economics acknowledge the laws of thermodynamics, based on the profession’s rejection one hundred years ago of Nobelist chemist Frederick Soddy who pointed out that our planet’s sun was the source of all life. Soddy’s critique was re-published in 2012 in Cartesian Economics (Cosimo Books, 2012).
One could go on. Economics is a useful profession, like accounting, to help us track our transactions and keep our books and balance sheets. Macroeconomics became an aberration in the search for mathematical precision and the illusions of general equilibrium in dynamic, evolving living societies. Humans refuse to behave like golf balls yet these general equilibrium models are still used by governments, academia and market players.
The fantasies of economists Arrow and Debreu of “market completion” turned into the nightmares of HFT, recurrent financial crises and the enclosure of traditional lands of indigenous peoples. Market fundamentalism is now threatening the planet’s last stands of virgin forests, lands and further extinctions of other species in their shrinking habitats.
I am reminded of senator Robert Kennedy’s view of GDP as measuring everything except that which makes us proud to be Americans and Oscar Wilde’s famous words that we can “know the price of everything and the value of nothing.”