Tuesday, June 7, 2011

An International Regulatory Regime

The price of silver went up. It then went down again.

Bloomberg reports that this fluctuation resulted in cries for the United Nations to stomp a regulatory boot down on the throats of investors in silver and gold.

"Commodity markets need international oversight, more transparency and intervention to deflate bubbles because increasing speculation means prices are no longer driven by supply and demand, the United Nations said."

A contemptuous unnamed Marxist at the United Nations sniped:

“Contrary to the assumptions of the efficient market hypothesis, the majority of market participants do not base their trading decisions purely on the fundamentals of supply and demand,” the UN agency said. “They also consider aspects which are related to other markets or to portfolio diversification.”

I know for certain that the writer is a Marxist because he has the market backwards. Marxism is based on skewed visions of the market.

The idea of the free market is that people are engaged in an ongoing process of adjusting their portfolios. As billions of people actively adjust their investments, they end up providing better information than one gets from a top down regulated market or in a fully socialized economy.

In the free market people make decisions based on their immediate surroundings. These personal decisions create a market that adjusts to global supply and demand better than a planned economy.

The unnamed Marxist in this post projected an absolutely absurd assumption onto the free market. The participants in a free market do not base their decisions on global analysis of supply and demand. They make their investing decisions based on their personal situation.

Global demand is determined by a summation of all of these individual decisions. The price of silver goes up when people feel it is better to have their cash in a precious metal than in a fiat currency.

The snit at the United Nations has the efficient market theory backwards.

The second idiotic assumption that the writer makes is that precious metal markets are not regulated.

The markets are highly regulated.

The "spot market" that people cite when pricing precious metals is produced by centralized exchanges like COMEX.

When I buy a coin at the coin store, the clerk looks up the price at the central exchange. The central exchange does not look at my purchase. The price I pay for coins is directly affected by the spot market. There are several degrees of separation between my local purchase and the centralized exchange.

The people on these exchanges are trading highly regulated contracts and futures. The regulations include short selling and margin positions.

When we look at the spike in silver prices we see that in the build up to the bubble the regulators at the exchange had very loose margin requirements.

The regulators at the exchanges tightened the margin requirements which reduced the money on the table for the trades. The tightened margin requirements led to a steep drop in prices.

The bubble was a direct result of the regulations in place.

The spike in prices is better explained as a result of actions of the regulatory regime, than as the result of a failure of the free market.

No comments:

Post a Comment