The gum of bubbles (Part 2)

The gum of bubbles (Part 2)

We ended last week by revealing a truth that the “markets do not know best”1,2. We also know that today, broker or speculator strategies are able to move markets. Meaning when they use large pools of funds to buy stocks, with the intent of driving prices up or down, depending upon the strategy. Traders can artificially extend price trends, reverse them, or dump them1,2. This kind of arbitrage (betting or hedging by: information leverage; price fixing; & a host of other manipulations traders use), are common. So common that we have trends whereby other traders simply follow the actions of a large or reputable trader (mimicking their trade strategies), often called a herd mentality1. It refers to instances where the “market” blindly follow trade patterns of traders with volume and/or reputation1,4. These are commonly observable facts, but a lesser-known consequence is that it generates self-fulfilling prophecies2. Put differently trades are attached to the beliefs of trader’s, so believing price trends or levels will move in a certain way, traders will act in “deterministic, herding” ways. So then, these very same deterministic or predictable responses, in itself have an impact upon the trade (valuation, pricing, risk, etc.)1-4. These features contribute to market crashes, failures, bubbles, etc. Traders try to discern patterns in financial asset prices to predict profit opportunities, but what they are ill aware of, is that “the very trading decisions they make, based on the information they collect, affect the price patterns they are trying to learn”1,3. Understanding this sector as a complex adaptive system is therefore necessary and important, so that prices actually reflect the real or intrinsic value of stock1,3. It may also help to set new rules that can reduce or even remove bubbles and crashes3. But since we must still accept that the global economy & stock markets are complex adaptive systems3,1, implies that we still have a very long way to go. Practically then it means: the rules are unknown + the products are exotic. Only few individuals are actively researching such initiatives3, like for example the Santa Fe Institute (SFI) work-group consisting of various experts, arguing the topic under “cognitive behavior and economics”3. The insights from this session yielded 3 areas of interest3: (1) the nature of social reality (e.g. what is being learned); (2) the social construct (e.g. accepting Fiat money); (3) the social aspects of cognition (e.g. imitating the behavior of others). It is thus not only important for traders to understand & grow systemic insights, all of us must improve our understanding of this knowledge-base as it affects us all directly. As an example, consider that today as you read this article, the actual derivative market value is unknown, or unknowable if we are to use correct scientific description.

Such facts and truths are almost incomprehensible - to think that our biggest global capital market (derivatives), was estimated at the lowest end, to be $1.2 Quadrillion in 2010 already4. Derivatives, as will be discussed in future publications, are financial instruments used extensively by the industry, yet the exotic nature of these instruments have allowed it to “run-away” because of the gospel in trusting the market (Efficient market Hypothesis). This is noticeably perilous, since a Quadrillion is 1000 times a Trillion, yet it is only part of the global financial systemic problems1. The over-valuation of global listed stocks are still be added to this number, whilst we must consider that the worlds collective annual gross domestic product (GDP) was at the time between $50-60 Trillion4, then the scale of the systemic time-bomb is purer1. Think of it this way, the total sum of things we produce, meaning our global GDP is literally thousands of times smaller than the derivatives market, low-end valuation or notional value. This is both weird & as scary as negative interest rates, used as the exotic gum to post-pone a number of looming Bubbles across the global financial & economic system. A system that is increasingly volatile & counterintuitive, with none of the key stakeholder groupings adopting a systemic perspective to address the phenomenon. If we look at global joblessness, poverty, disparity, inequality and lack of social justice, then stalling a systemic fix for the global economic system, by using exotic gum, like skewed treaties & trade agreements (e.g. TTIP), then our self-destruction is inevitable1.

References:

• Udemans, F., 2008, The golden thread: escaping socio-economic subjugation, an experiment in applied complexity science, Authorhouse UK;

• White, M., 2010, Complex Adaptive Systems in Finance and Strategy, https://www.oocities.org/whitemark1/; Mantega, M., & Stanley, H., 2000, An introduction to Econo-physics: a correlation and complexity in Finance, Cambridge University Press; Crocket, A., 2011, Reforming the global financial architecture: Key note address – Asia and the global financial crises; Asia Economic Policy Conference; Claessens, S., & Kodres. L., 2014, The regulatory responses to the global financial crisis: Some uncomfortable questions: IMF working paper; Research department and institute for capacity development;

• Arthur, W.B. et al, 2013, Economics and the Modern Theories of Cognitive Behavior, SFI working paper;

• Cohan, P., 2010, Big risk: $1.2 Quadrillion derivatives market dwarfs world GDP, Investor center, InvestorCenter;