Do Markets Sort Themselves Out?

[Wildy]

I have managed to get myself into something of a comment argument with a guy on Youtube on the market.

It started when I responded to something he said on one of the videos from the Hollywood writers during the strike and one of the things he said was that the market always sorts itself out.

Is this a true statement? Or are there situations where in fact the market cannot sort itself out?

From what I understood the Great Depression was an example of where the market didn't really sort itself out the actions of certain people helped to pull the world out of the situation they are in. Something here tells me that my line of thought might be faulty.

[this charming man]

Well, apparently order only can come from an intelligent being... (http://forums.randi.org/showthread.php?t=103807)

[brodski]

It depends what you mean by "sort themselves out", the market will always, by definition, deliver market outcomes. there are those that believe that by definition whatever outcome the market delivers is the optimal outcome, there are others that disagree.

until you (and he) understand what he mans by his statement then you're not going to get an answer.

[Francesca R]

Is this a true statement? Or are there situations where in fact the market cannot sort itself out?Markets do not always exist. They do not spontaneously arise for every situation where there is demand, or supply, or both. Where a market is missing, it obviously cannot act to clear supply or/and demand. Some types of transactions tend to arise (and clear themselves) spontaneously all over the place. Others require enforced constructs of protected rights and legally binding contracts or they won't happen. Still others do not exist even if these things are in place.

Markets can fail to "sort things out" when the interaction of supply and demand generates external costs and benefits outside the scope of the transaction the market is pricing.

Also markets are driven by collections of individuals responding to incentives. If these incentives are highly positively correlated, then the action of the market clearing itself can be extreme--such as destroying massive wealth. In such circumstances a non-market actor, with uncorrelated incentives (sometimes called a lender of last resort) can bring about a cleared market with significantly less adverse social costs.

This is all I can think of in the absence of more specifics to your OP

[Wildy]

What would you like more specifics on?

[brodski]

What would you like more specifics on?

What either of you mean by "sort themselves out", for a start.
:)

[69dodge]

Also markets are driven by collections of individuals responding to incentives. If these incentives are highly positively correlated, then the action of the market clearing itself can be extreme--such as destroying massive wealth. In such circumstances a non-market actor, with uncorrelated incentives (sometimes called a lender of last resort) can bring about a cleared market with significantly less adverse social costs.

I don't understand. Can you give an example?

[Tokenconservative]

No, never...at least not without government assistance.

We've seen it time and time again, where ONLY by the government meddling in...er, I mean tweaking the markets will they sort themselves out.

Tokie

[Francesca R]

I don't understand. Can you give an example?A striking example was the Asian FX crisis (http://en.wikipedia.org/wiki/Asian_crisis) just over a decade ago.

The ongoing ructions in fixed income derivatives is another--this has prompted extremely large excess cash provision to money markets by central banks (non-market actors), surprise interest rate cuts, and current talk of emergency (temporary) tax cuts. The last of these is directed at shoring up consumer spending [in the US] but the first two were targeted specifically to forestall what would have been the unfettered market outcome (which could have been greater panic and perhaps financial institutions failing and fear of system-wide collapse

The free market would have bankrupted Northern Rock plc (http://en.wikipedia.org/wiki/Northern_Rock#2007_Credit_Crisis) in a matter of days had it not been arrested, and this could have led to multiple bank-runs in the UK which could then have spread offshore. (Northern Rock is still very likely to end up as a fully state-owned bank for a while, but the potentially very nasty side effects were stopped in their tracks.)

[Tokenconservative]

It depends what you mean by "sort themselves out", the market will always, by definition, deliver market outcomes. there are those that believe that by definition whatever outcome the market delivers is the optimal outcome, there are others that disagree.

until you (and he) understand what he mans by his statement then you're not going to get an answer.

By "others" you mean of course Keynesians and "others" who desperately want to believe in thoroughly repudiated economic theories.

But you are right otherwise. Modern economic theory does not hold that there is some magical baseline modern markets aspire to. There are ups and downs in the markets, whether it's for cow manure or currency...they go up, and they go down.

One thing you can be sure of, in most cases post-1930s, what government does when it meddles in the markets in order to make them "better" is turn what may or may not be a "bad" (again, outside Keynesian economics, this has no real definition in economics) situation into a stuttering nightmare situation.

Tokie

[Tokenconservative]

A striking example was the Asian FX crisis (http://en.wikipedia.org/wiki/Asian_crisis) just over a decade ago.

The ongoing ructions in fixed income derivatives is another--this has prompted extremely large excess cash provision to money markets by central banks (non-market actors), surprise interest rate cuts, and current talk of emergency (temporary) tax cuts. The last of these is directed at shoring up consumer spending [in the US] but the first two were targeted specifically to forestall what would have been the unfettered market outcome (which could have been greater panic and perhaps financial institutions failing and fear of system-wide collapse

The free market would have bankrupted Northern Rock plc (http://en.wikipedia.org/wiki/Northern_Rock#2007_Credit_Crisis) in a matter of days had it not been arrested, and this could have led to multiple bank-runs in the UK which could then have spread offshore. (Northern Rock is still very likely to end up as a fully state-owned bank for a while, but the potentially very nasty side effects were stopped in their tracks.)

So you are saying that banks should be somehow exempted from free market pressures?

Why?

Tokie

[Francesca R]

So you are saying that banks should be somehow exempted from free market pressures? Why?It is the public that is provided with protection from free-market pressures. Northern Rock's deposits were not given a government guarantee to backstop shareholders per se.

No country has a free-market in short term interest rates. Either central banks (mandated by government) or governments themselves rig this market.

No country lacks a lender of last resort.

185 out of 193 countries are members of the Bretton Woods international organisations like the IMF and the World Bank.

None of these things are necessary if the free market, pressures and all, is deemed fine on its own.

[The Atheist]

Two obvious answers to the OP:

If "sort itself out" means reaching a natural level, then the answer is yes.

If "sort itself out" means stay afloat regardless of government intervention, then the answer is as obviously no. Two words: Fed Res*.

*Replace with local Treasury for non-US residents.

[Gazpacho]

Companies can't just behave willy-nilly and remain in business. If their customers don't kick them to the side, investors will. Then they will find or create another company to do the same thing. So in that sense, a market sorts itself out.

In the case of the Great Depression, top business leaders became enamored with misguided ideas about buying power that ignored the interests of investors. Instead of cutting jobs, saving money, and using it to grow again, they just ignored the storm until they ran out of money (at which point employees lost their jobs anyway).

[MilwaukeeMike]

I think the only way you could say the markets can sort themselves out is by having a completely open market, free of regulation, tax benefits for certain dead industries, "stimulus packages" (Wow, thanks Bush), trade tariffs, currency pegs, a fed that panders to the market, and price controls; then yes, maybe the market could sort itself out.

I think if we actually had free markets in the United States, then simple supply and demand theory would kick in, and the economies "bid - ask" spread would converge, and we would be out of this recession. However, Washington has muddled with the markets for some time which, I think, creates the never ending cycle of bailouts and rate cuts. Everyone needs to remember the job of the fed is to monitor inflation, not prop up the domestic equity markets. That’s my two cents.

[brodski]

If "sort itself out" means reaching a natural level, then the answer is yes.


That natural level could of course be the complete sense of the market.

Which gets back to my point about the circular definition, if one defines the "natural level" as whatever the market delivers, then by definition all markets will operate at their natural level, even if that level is zero.

[JonnyFive]

I think if we actually had free markets in the United States, then simple supply and demand theory would kick in, and the economies "bid - ask" spread would converge, and we would be out of this recession. However, Washington has muddled with the markets for some time which, I think, creates the never ending cycle of bailouts and rate cuts. Everyone needs to remember the job of the fed is to monitor inflation, not prop up the domestic equity markets. That’s my two cents.

What do you mean by "converging" the bid-ask spread? You mean the bid price on securities would equal the ask price on securities? When would this ever happen in a non-theoretical market?

The bid-ask spread on what in what market, exactly? Why would this be either possible or desireable?

Also, the Fed's job isn't only to monitor inflation. It is specifically tasked with trying to maintain stability in several areas of the economy (including prices and interest rates) as well as trying to maintain full employment, among other things. Helping the domestic equity markets, whether or not you believe it is a good idea, could potentially fall within that mandate.