The currency turmoil is a reminder that this is the decade of price volatility in the international markets for just about everything. There is a doctorate waiting for the economist who investigates the thesis that perfect information is one of the root causes of this problem.
Perfect information is a necessity for a perfect market, but it could well be that ignorance has played an unrecognised part in keeping price movements orderly. The seventies have seen a proliferation of “instant information” in international markets. The word no longer spreads by telephone and ticker tape but on TV screens right in front of the traders. Flash Flash Carter Acts To Save Dollar. There is time for only knee-jerk reactions, and the trader sees instant confirmation that the rest of the pack is moving with him.
In theory perfect information should allow supply and demand to determine a just equilibrium price. But its practical result in a changing world is wild oscillation about the shifting point of equilibrium.
An engineer knows that a perfectly elastic system will accommodate itself perfectly to static forces acting upon it. But he also knows that if these forces change such a system becomes a nightmare. It never stops jumping about the just position. So if his mechanism lacks friction, he introduces imperfection into it in the form of damping to keep his springs under control.
It is this damping that is lacking in the international markets for currencies, securities and commodities. The old, natural friction has been systematically removed. It has become steadily easier to deal or at least to try to deal: it now suffices to pick up the phone. The news that prompts the decision to deal no longer filters through to people, but hits many powerful investors and dealers simultaneously. The result is markets which are closer to being perfect and to being perfectly unbearable.
The thesis is hard to prove. In the currency market it is difficult to unravel cause and effect in the aftermath of the Bretton Woods system. Other variables have supposedly been on the increase which markets lump together under the catch-all of “heightened uncertainty”. The rise of multi-national business has greatly increased the quantities of money being shifted around. Under such circumstances an argument beginning “other things being equal” gets off to a weak start.
Yet the London Discount Market Association, the sobriety of whose judgement can probably be relied upon, told the Wilson Committee unequivocally that the introduction of an electronic market information system had “irrevocably changed the sterling money market” and made it “a great deal more sensitive and volatile.” Instant information led to a “tendency to over-react to avoid having to deal at the wrong rate.”
Faced with an increasingly frictionless and jittery foreign exchange market, governments have tried to improve matters in two ways, both of which bring a smile to the face of an engineer. First they have tried “dirty floating” with central bank intervention: this does not, alas, introduce damping into the system, only an extra large, powerful and rather conspicuous spring. The other favoured solution is to say “the ride is too bouncy, let us do away with the springs altogether.” This is the EMS approach and unless the road ahead is very smooth it has painful consequences.
The engineer would advocate artificial friction to replace the natural friction which has gone. Among the proposals made so far the Crawling Peg type of exchange rate system would appeal to him most. Or he might, with a glint in his eye, suggest that the new instant electronic information and trading networks offer their own solution to the problem of frictionlessness they have created.
Great computer minds should design an electronic trading network which allows prices to crawl at a rate which varies with the market forces acting upon them. Using either a central fund or employing the reserves of participating central banks it would reactively rather than actively undertake the purchases or sales needed to provide the necessary damping forces.
A doctorate for a thesis on the impact of instant information. But a Nobel prize for the invention of a cybernetic monetary system.
