Friday, October 10, 2008

Economic turmoil: Standstill

The Malay folk wisdom states, Bila sesat, balik ke pangkal jalan which can be loosely translated as, If you are lost, return to the original point. Think about it. The conventional theory is that the market place is a venue that allows buyers and sellers to transact. This transaction is on a willing buyer-willing seller basis. The transaction is successful when the buying price matches the selling price. They call this rational behaviour. They call this an efficient mechanism for price-fixing.

This is the cornerstone assumption that drives the modern economy. This is the feature that regulates the laws of supply and demand. I believe it works well in the real economy where goods are produced and services supplied.

The theory gets complicated and, ridiculous when applied to stock markets which deal with abstractions of the real world. What is a share? What is equity? What is a derivative? We can look it up in Wikipedia, of course and, yet, find no explanation that allows us to understand why shares of solid companies that have posted good sales turnovers and good profits are being sold in stock markets over the past few weeks and, certainly, in the past several days.

Throw out the theory of rational behaviour for stock markets
It is obvious that in this time of financial crisis the theory of rational behaviour can no longer apply to the stock market. Players have become irrational.

The market place becomes irrational when the seller sell in the belief that the price transacted is going to become lower and lower and, this irrational selling behaviour is mirrored by the buyer who chooses to wait before agreeing to buy in the shared belief that the price transacted is going to become lower and lower. This is a self-fulfilling prophecy.

Crisis of confidence
Read any media report and you see the word confidence or, the lack of it, being bandied about. There is a clear consensus that the stock market has become irrational.

We can laugh at the silliness. Except that this irrational behaviour, this crisis of confidence is now affecting the real economy where goods are manufactured for sale and services are available to be supplied. The real economy is affected when businesses cannot find additional working capital. The real economy is affected when people cut down their consumption of goods and services.

Cutting out the crap
If it is agreed that the stock market is behaving irrationally, then governments should have the courage of parents dealing with unruly children that are fighting over candies and lollipops - just stop them.

Yes, what I am suggesting is a 30-day standstill on global stock markets. Just tell them to close shop for 30 days.

This period can be used by governments and regulators to restore confidence.

Right now, governments and regulators are placed in the impossible position of having to respond to the irrational behaviour in the stock market. Think about it. This is like trying to negotiate with an insane person. If we would not conduct negotiations with an insane person at any time, why should governments and regulators deal with an insane market?

This is necessary. This will allay fears. This will restore confidence. This will bring back some semblance of rational behaviour.

This is radical. This is drastic.

If only Dr M was President of IMF. He is one person who would listen to the view offered here. And, he would be able to scold everyone and, restore order. I say this with all seriousness.

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