chracterstics of financial marketing on basis of cartoon published in 1987

Essay

Characteristic of Financial Market

on

Basis Of

Cartoon depiction

TABLE OF CONTENTS

Ch. No. Title Page No.

1. Background of Study 3

1.1 The General Theory 3

1.2 Keynesian rational 5

1.3 Convention 6

2.Depiction from the above humoristic cartoon 8

2.1 1929 Market Crash 9

2.2 1987 Market Crash 10

3. Conclusion 11

List of References 12

Background of Study The General Theory

It is necessary to begin with a short summary of The General Theory to clearly understand

about the speculative and unpredictable nature of the market. Non economists are unable to

explain the fundamentals of the macroeconomics based on the General Theory given by John

Maynard Keynes, the eminent British macroeconomist and Bloomsburg intimate. Some work

is required to narrow down the disciplinary divide between the economists and the literary

critics. In his introduction to The General Theory, Nobel Prize winning economist Paul

Krugman gives a lucid summary of Keynes’ argument expressed as four bullet points:

Economies can and often do suffer from an overall lack of demand, which

leads to involuntary unemployment.

The economy’s automatic tendency to correct shortfalls in demand, if it exists

at all, operates slowly and painfully.

Government policies to increase demand, by contrast, can reduce

unemployment quickly.

Sometimes increasing the money supply won’t be enough to persuade the

private sector to spend more, and government spending must step into the

breach”.

The first bullet point explained by Paul Krugman expresses the notion of “under

consumption” and is worth discussing in some technical detail, as it establishes the premises

from which the rest of Keynes’ argument follows. Prior to the publication of The General

Theory, orthodox economics was based on Say’s Law and its subsequent canonization as the

“law of markets.” Briefly, Say’s Law postulated that the aggregate supply of products in the

economy created their corresponding aggregate demand, i.e. the sale of Product A by Person X paid for Person X’s purchasing of Product B from Person Y, which in turn paid for Person

B’s purchasing of Product Z from Person C, ad infinitum. The market was thought to

stabilize at a defined and unique equilibrium point where aggregate supply equals aggregate

demand, and full employment levels sustained uninterrupted production and consumption

patterns across all commodities. Say’s Law enjoyed privileged status amongst nineteenth

century market theorists, but reached its theoretical break point during the Great Depression,

when confronted with depressed consumption levels and persistent unemployment.

In response to the limited explanatory power of Say’s Law during the Great Depression, Keynes challenged its equilibrium assumption by expressing “aggregate supply” and

“aggregate demand” as functions of the employment level. Instead of modeling supply and

demand as autotelic processes, Keynes derived both from the number of men allocated to a

particular productive function: the aggregate supply function was the output, Z, from

employing N men (Z = φ(N)), and the aggregate demand function was the proceeds, D, from

employing N people (D = f(N)), whereby the aggregate volume of employment would be

given by the value of N where Z=D. Keynes wrote Say’s Law, assumed that “f(N) and φ(N)

were equal for all values of N,” but if this were true, “competition between employers would

always lead to an expansion of employment up to the point at which the supply of output as a

whole ceases to be elastic” . More simply put, Say’s Law categorically asserted that full

employment would be an economic constant, a hypothesis that flew in the face of the 1930s’

economic experiences.

To account for recessionary economics, Keynes formulated the relationship between

employment and aggregate supply and demand as follows: increases in employment (N)

would increase aggregate income and aggregate consumption but not in a one-to-one

relationship, as an individual would not always consume 100% of what he or she earned. He

or she would have a choice, Keynes wrote, between consuming, saving, and investing his or

her savings. The individual’s propensity to consume would depend not only on an increases

in his or her earnings, but on his or her “the current amount of investment”; this, in turn,

would depend on “the relation between the schedule of the marginal efficiency of capital and

the complex of rates of interest on loans of various maturities and risks”, i.e. a future

discounted cash flow (DCF) calculation of the internal rate of return from an investment

made today. Keynes claimed that both the propensity to consume and the propensity to invest

would set the new rate of employment, which could only correspond to full employment

under a very specific set of circumstances.

From there, the prescriptive recommendations of The General Theory were easily derived. In

times of widespread unemployment, simply printing more money (as Say’s Law advocated)

would not necessarily increase economic activity, as individuals would be inclined to allocate

that money towards savings or investment, rather than consumption. Rather, for consumption

to increase, individuals with little or no income – mainly the unemployed – would have to

find means of generating income in order to increase their real purchasing power. From this

observation, Keynes concluded, “A somewhat comprehensive socialisation of investment will

prove the only means of securing an approximation to full employment. If the State is able to

determine the aggregate amount of resources devoted to augmenting the instruments [of

production] and the basic rate of reward to those who them, it will have accomplished all that

is necessary”. This section of The General Theory was forever memorialized as Keynes’

famous gesture towards the contemporary welfare state: governments ought to establish

public service programs that provided employment for the unemployed, and subsequently

increased real purchasing power in the economy.

Keynesian Rationality Keynes never gave his readers a specific definition of rationality in The General Theory, but

did provide one in his earlier work A Treatise on Probability. Keynes wrote: “When once the

facts are given which determine our knowledge, what is probable or improbable in these

circumstances has been fixed objectively, and is independent of our opinion. The theory of

probability is concerned with the degree of belief which it is rational to entertain in given

conditions, and not merely with the actual beliefs of particular individuals”. The rationality

of an individual has nothing to do with whether or not a given belief is cohesive, quantifiable,

or even correct, e.g. “The value of gold will rise 25% this year,” “Colonial politics will make

trade more profitable.” Rather, rationality represents the degrees to which presumed

informational constraints, what Keynes calls “knowledge,” inform our probabilistic

assessments of future outcomes. For Keynes, rationality is never localized in the substantive

end state of a process, e.g. a botched investment based on incorrect cash flow calculations,

economic deregulation. Rather it resides in the procedural assessments by which an investor

has reached that end.

Given this definition of rationality, there exists an important theory of investment psychology

that Keynes outlines in The General Theory. Keynes suggests that the calculation of

investment yields, what he calls investor’s “long-term expectations”, are based on “partly

existing facts” and “partly future events which can only be forecasted with more or less

confidence”. Future valuations are arrived at by projecting the current state of affairs into the

future, and by accounting for any modifications that may alter existing expectations. The

ritualized calculation of long-term expectations based on present day beliefs is an example of

what Keynes calls “a convention”.

Convention

Michelle Baddeley and other economic theorist propose that “convention” represents the

convergence of investor beliefs in environments plagued with informational uncertainty. To

make the link to Keynes’ definition of rationality, it should be added that conventions are

dialectically and dynamically updated in proportion to changing probabilistic knowledge. It is

no accident that in his description of convention in The General Theory, Keynes echoes the

same descriptive characteristics that he attributed to rationality in A Treatise on Probability. Convention, Keynes believed, represents the pooling of investor belief at a point where “the

existing market valuation, however arrived at, is uniquely correct in relation to our existing

knowledge of the facts which will influence the yield of the investment, and that it will

change in proportion to changes in this knowledge”.

Because conventions are overtly social phenomena that arise amidst imperfect information,

they reflect a totalizing overlap between individual and aggregate belief and behaviour – they

dialectically proxy “the truth.” To give an example: an individual investor will act according

to a particular convention (e.g. “Buy 100 shares of Western Union at $2 per share!”), and that

convention will self-perpetuate due to the collective beliefs and subsequent acts of multiple

investors (e.g. “Western Union’s stock price just rose from $1.92 to $2!”). Convention, then,

cannot rightly be opposed to rationality, as it represents the best, i.e. most informed, or most

calculated, valuation that investors arrive at by evaluating the only thing they can evaluate –

each other’s beliefs.

Keynes argues that professional investors make money by anticipating disproportionate

swings in investment valuations, and moving their money around in response to short-term

gains and losses. Highly liquid investments make speculation cheap and easy, and aggregate

economic performance becomes dependent on the casino-like strategies of Wall Street and

the London Stock Exchange.

Immediately after presenting his assessment of speculation, however, Keynes issues a caveat

against reading too much into irrationality: “We should not conclude from this that

everything depends on waves of irrational psychology. On the contrary, the state of long-term

expectation is often steady Our rational selves choosing between the alternatives as best we

are able, calculating where we can, but often falling back for our motive on whim or

sentiment or chance”. In one sense, the limitations help us marginalize complaints about

speculation by pointing to its relative infrequency. The implication is that the Keynesian

market is neither inherently irrational, nor do investors constantly invoke whim, sentiment, or

chance when there is information they can leverage. Instead, behaviour is dictated by

convention only when there is no pure informational basis for one investment strategy over

another. Because information aggregates and markets self-correct over time, long-term

expectations will converge at some “true” valuation estimate, rather than exhibit constant

volatility. The default setting for both individuals and the market is rational decision-making

and rational outcomes, even if imperfect or asymmetric information momentarily forces

individuals to deviate from strictly rational calculations.

However, speculative behaviour can also be accounted for as a type of convention par

excellence. Speculative investment decisions are never motivated by a desire not to maximize

profits or expose the “true” value of a stock. The animalistic investor, Keynes argued, derives

his “spontaneous optimism” from a punctuated, market-wide convention of exuberance.

Moreover, for the critics that speak of speculation with disapproval, Keynes argued that a

certain amount of conventional self-deception is needed if enterprise is not to “fade and die”. Optimism is the only means by which credit can circulate.

Decision-making based on convention is, for Keynes, the most rational method of procedural

evaluation possible in imperfect informational environments, even if the end result is sub-

optimal asset allocation. Conventions absorb “whim, sentiment, and chance” within a

dynamic and dialectic totality, tempering impulse and stabilizing the systematicity of

valuation and exchange.

Depiction from the above humoristic cartoon The above cartoon depicts the speculative and unpredictable nature of the stocks and the herd

behavior of the stock market. As has been explained in the general theory by Keynes the

decision is made on the basis of convergence of investor beliefs in environments plagued

with informational uncertainty. This cartoon depicts how the information has been perceived

by the investors as shown the original message was that the stock could really excel which

was wrongly perceived as sell by someone and this phenomenon self-perpetuated due to the

collective beliefs and subsequent acts of multiple investors. In the second part of the cartoon

similar instance happened when Good Bye was perceived by the investor as a Good Buy this

also self-perpetuated and became the act of multiple investors. It depicts the lack of adequate

information and speculation the investors made on the basis of the thinking of the other

investors which led to multiple investors either buying or selling in a share on the basis of a

rumor. Above cartoon can also be depicted as following herd behavior by the investors as

they followed the decision made by the one investor on the basis of lack of information and

then followed him without having the appropriate information. This characteristic has also

led to various historic ups and downs in the stock market two huge examples that could be

1929 crash and 1987 crash of the stock market which have been briefly explained below.

1929 Crash

Monthly Chart of Dow Jones Index for 1929 The monthly chart shows the eventual market low in 1932. Although investors would have

recovered their losses earlier due to dividends, the DJIA did not make it back to its 1929

highs until 1954. Some economists believe that some of The Causes of the 1929 Crash was

Stocks were Overpriced, Massive Fraud and Illegal Activity, Margin Buying, Federal Reserve

Policy, Public Officials' Repeated Statements. Many public officials commented that the

stock prices were too high. For example, the newly elected President of the United States,

Herbert Hoover, publicly stated that stocks were overvalued and that speculation hurt the

economy. Hoover's statement suggested to the public the lengths he was willing to go to

control the stock market. These kinds of statements encouraged investors to believe that the

market would continue to be strong. This statement was perpetuated among the investors and

this led to 12,894,650 shares changed hands on the New York Stock Exchange-a record,

which could be one of the causes of the Crash.

1987 Crash

Monthly Chart of Dow Jones Index for 1987-1988 Reasons which are sited for the 1987 crash are Margin calls, program trading and difficulty

obtaining information. Difficulty obtaining information Uncertainty and herd behaviour also

contributed to the crash. With rapidly changing prices, information about current market

conditions was difficult to obtain. Price quotes for stock and stock indexes were not

necessarily reliable since some stocks were temporarily not open for trading. Rumors about

market closings added to the confusion. Given the uncertainty, investors apparently sought to

sell and close out their positions. With the dearth of reliable information, herd behaviour

reportedly became common. Robert Shiller surveyed market participants promptly after the

crash and many conveyed to him that, on the day of the crash, they were reacting more to the

price movements than to any particular news.

In both the examples cited above speculative nature and herd approach of the market is quite

evident as they are cited as one of the main reasons for the market crashes in 1929 and 1987.

Conclusion All the technical analysis uses the fact that the past events are likely to be repeated in the

future and on basis of these facts various predictions are given for the future. Technical

analysis is the search for patterns that repeat themselves across prices, like for example a

head and shoulders top pattern. But there are certain examples where the market has followed

a random or unpredictable approach rather than following as per predictions by the technical

analysis. Market is highly affected by the speculations and rumors as is seen in some cases of

the market crashes. Also there are various examples that show how the rumors have made the

stock price rise or to fall to a great extent which again shows the speculative characteristic of

the market. In the end it would be appropriate to say that the markets heavily speculative and

are unpredictable and cannot be alone judged by the technical analysis alone.

List of References http://www.federalreserve.gov/pubs/feds/2007/200713/200713pap.pdf (accessed on March

11, 2014)

http://www3.nd.edu/~jstiver/FIN462/US%20Market%20Crashes.pdf(accessed on March 11,

2014)

http://modernism.research.yale.edu/wiki/index.php/The_General_Theory(accessed on March

12, 2014)

http://www.math.uchicago.edu/~lawler/srwbook.pdf(accessed on March 13, 2014) JSTOR: The Economic Journal, Vol. 101, No. 405 (Mar., 1991), pp. 276-287(accessed on

March 11, 2014)

Economics: Principles and Policy - William J. Baumol, Alan S. Blinder - Google Books(accessed on March 12, 2014) Probability and uncertainty in Keynes"s The General Theory - 16387.pdf

http://discovery.ucl.ac.uk/16387/1/16387.pdf