Grit is Good

Feb 21, 2012 Howard Davies

Nowadays, many are questioning the old assumption that greater market efficiency is always and everywhere a public good. Phrases like “sand in the machine” and “grit in the oyster,” which were pejorative before the 2008 financial crisis, are now used to support regulatory or fiscal changes that might slow down trading and reduce its volume.

PARIS – The United States is widely recognized as possessing the deepest, most liquid, and most efficient capital markets in the world. America’s financial system supports efficient capital allocation, economic development, and job creation.

These and similar phrases have been common currency among American legislators, regulators, and financial firms for decades. Even in the wake of the financial crisis that erupted in 2008, they trip off the word processors of a hundred submissions challenging the so-called Volcker rule (which would bar banks from making proprietary investments). The casual reader nods and moves along.

But there are signs that these assumptions are now being challenged. Prior to the crisis, regulatory authorities focused mainly on removing barriers to trading, and generally favored measures that made markets more complete by fostering faster, cheaper trading of a wider variety of financial claims. That is no longer the case. On the contrary, nowadays many are questioning the assumption that greater market efficiency is always and everywhere a public good.

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Gordon Shedd Feb 26, 2012

Bravo, Director Davies! The shopworn, market-efficiency-based arguments for maintaining the status quo need to be called out for what they are--the unthinking regurgitation of economic dogma. Efficiency is used as THE excuse for every failing of laissez faire free markets, and for tolerating a destabilizing financial system that doesn't serve the markets so much as play them. The hypocrisy of rationalizing greedy and sometimes irresponsible behaviors in the name of efficiency is never pointed out, and probably not even understood by the perpetrators. How is it efficient to allocate capital, preferentially, to feed consumer markets that consist largely of marketing-driven,"lifestyle" purchases of new houses, new cars, new appliances, new electronics, new designer clothes, and the like to replace similar items that are still perfectly servicable? If consumers were ever encouraged (e.g., by finite resources) to care about efficiency as much as free-marketeers now profess to, then consumption-growth-based economic dogma would be revealed for the religion it is, the economies built upon its precepts would implode, and the current, post-recession output gap would be looked back upon as we now marvel at Roman aqueducts.
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Paul Hanly Feb 24, 2012

how can anybody claim the market is efficient when it varies by 50% in 12 months.

The volatility of the market is far greater than the volatility of the economy, so where is the efficiency in pricing prospects for the economy?

Price discovery is extremely poor if something can change in price by 50% in twelve months, or within a few months as in 1987. There are commonly changes in price of 10% in a month or two.
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Tony Ph Feb 23, 2012

Balance is good.
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Procyon Mukherjee Feb 22, 2012

The insightful article draws a case in favor of efficiency of markets and the instruments that market participants now use through technological advancements that have triggered trading at lightening speeds thus increasing turnover by several times. I am curious to know what Christopher A Sims would have said to the rationality of market participants in the wake of limited information and limited attention that is available when such turnover crosses the threshold value. The modeling of such human behavior can hardly be perfect given that no rational choice however made under perfect information could tide over the impending challenges that limited nature of attention forces us into; the stochastic randomness of outcomes could hardly be a point to celebrate about grit or otherwise as no rational choice could be made with such limited attention span to a range of information, which on the contrary is a point in favor of 'rational inattention'.

Procyon Mukherjee
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Zsolt Hermann Feb 21, 2012

As a result of the crisis we start to scratch the surface, that we are living in the wrong system.

Our present way of life, the way the political, economical structure is build is false, it is completely unnatural and this is the reason we have run into the global crisis, which is more accurately a system failure requiring a complete restart.

Of course admitting it is very difficult, we got used to this lifestyle, we have been brainswashed by its machinery for decades, we do not know any other system or way of life, thus unfortunately it seems we have to advance to the brink of a frightening, huge collapse to understand where we are and what we are doing.

But basically all our life is based on over the top, unnecessary consumption which we are forced to do against our own desires, since our "desires, cravings" for these goods are prgrammed in us by a very clever irresistable machinery, despite most of the time the products being directly harmful for us. To enable this over the top consumption way beyond our means of course we need credit, more and more of it, which made the initially simple useful means of money the main object of desire.

And from there on banks, the financial system has become the most powerful element in our system, and even today whenever there is a problem, the banks are bailed, sustained first even at the expense of the every day life of millions of people. We always look at the financial markets as indicators of our state, the "health of our system".

Sooner or later we will have to look, and accept this lie we are living. If it will not be ourselves, proactively changing the system, the crisis will destroy it very soon, but then the "unregulated default" will make recovery much more difficult.
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