Disequilibrium Analysis of Price Formation – Part 2

Courtesy of Professor Fekete @ NASOE:


We are now ready to discuss the co-ordination problem of economics and to see how entrepreneurs approach it through arbitrage. It will appear that our introduction of arbitrage as the generic form of human action, that underlies all the multifarious activities of entrepreneurs in pursuit of pure entrepreneurial profits, is insightful. It focuses on what is important while deemphasizing what is less important or unimportant in the activities of entrepreneurs when looked at from the point of view of the market process. It also leads to the classification of entrepreneurial strategies as we treat the coordination problem.

The coordination problem and the landscape of spreads

Lack of coordination or the presence of disorder in society represents an opportunity for gain, even though every instance of this remains hidden to most observers until it is exposed by entrepreneurship. Once the opportunity is being exploited, coordination overtakes disorder and the profit potential disappears. There prevails in society a spontaneous tendency for greater co- ordination driven by entrepreneurship. In fact, it is the existence of this process that makes it possible to have theoretical economics as opposed to economic history. But how does the entrepreneur diagnose the presence of disorder? He surveys the landscape of spreads. The latter furnishes an accurate picture of the state of coordination or the lack of it. In more details, narrow spreads indicate a higher and wide spreads indicate a lower state of coordination.

The entrepreneur picks a spread that appears unreasonably wide to him. He then exerts his coordinating influence on the spread through arbitrage using the corresponding straddle. The landscape of spreads is not to be visualized as rigid relief map but rather as a fine cobweb, every node of which is inter- connected with every other. Disturbance at one node will affect the state of every other node. Accordingly, the entrepreneur attacking one spread through arbitrage will transmit information to and will influence the width of every other spread. In order to understand the coordination process more fully we must look at various entrepreneurial strategies. We isolate two of them: the defensive or retrospective (backward-looking) strategies utilizing horizontal arbitrage, and the aggressive or prospective (forward-looking) strategies utilizing vertical arbitrage. As we have seen, producers of nth order goods act as arbitrageurs on three counts: (1) they are doing vertical arbitrage between the nth and (n + l)st order goods; (2) they are doing horizontal arbitrage at the level of output (goods of order n); and (3) at the level of input (goods of order n+1). Different types of arbitrage have different roles to play in the market process. First we look at the role of horizontal arbitrage. Continue reading

Coordination of the Natural Social Interaction

Courtesy of Sandeep Jaitly @ Fekete research.com:

The aim of this paper is to show that the monetary/financial system that develops is a representation of some form of productive social interaction. The monetary system is the consequence, not the cause, of productive social interaction.

Money is defined as that substance which is the ultimate extinguisher of any debt. As a consequence the substance(s) used as money must have perceived value in and of itself. Menger described the iterative procedure by which a substance was promoted to money by the people themselves in ‘The Origin of Money (1892.)’

There is no record of the date at which humanity first gave value to gold and silver because the Sanskrit literature that first referred to them cannot itself be accurately dated. However, we can be sure about the mechanism that resulted in their promotion to the monetary metals courtesy of Menger.

The substance which is promoted to money will necessarily have very high inventory to primary production ratio (also known as stocks to flow ratio.) This arises from the fact that incremental additions to one’s personal holdings of this substance do not affect one’s personal terms of acceptance of this substance. This substance must exist, just as the largest number amongst a set of numbers must exist.

If one arranges all commodities on earth by the stocks to flow ratio, two metallic commodities stick out markedly: gold and silver. The extent by which these two metals differ from the next substance in terms of stock to flow is astounding and testimony to the exceptionally long period of time over which humanity has valued these two metals. There can be no other explanation.

With the monetary substance chosen, the evolution of the financial and payment system – merely a mirror of the natural ‘social interaction’ that arises from the fact of our own existence – can begin.

Economic activity is a base synonym for ‘social interaction:’ the farmer sending wheat to the miller who sends flour to the baker who makes bread for consumption. The crude extractor sending oil to the refiner who sends on refined petroleum distillate to the retail pumps. These are all examples of social interaction. Interaction that is not related per se to the medium used for money. Interaction that occurs by the very nature of our existence. Interaction that must recur for the maintenance of our existence.

A defined amount of the monetary substance is the unit of account of multiple aspects of this social interaction. An extended social procedure stretched over countless millennia itself gave birth to the monetary media, so it is quite clear to see that neither the monetary substance itself, nor the amount in existence, would influence that social interaction.

Social interaction occurs in different ‘forms’ and ‘frequencies.’ For example, the sale of bread by the baker is pretty much guaranteed whereas the sale of the new jet engine to the aircraft company is not. This is an example of differing forms of social interaction.

The construction of an airport takes a different period of time (usually) to the construction of a residential home. This would be an example of differing frequencies of social interaction. Continue reading