The large drop in financials of all sorts – both conventional and crypto – have people wondering what went wrong. What could have triggered this stunning sell off? What has spooked the markets? When there are no obvious answers, and there really aren’t this time around, it tempts people to believe that markets themselves are broken. Surely prices should behave more rationally and predictably. There is no justification for prices to swing this much.
I’m here to argue a difficult truth. So long as markets are in charge, there is no such thing as a right, just, moral, rational, or stable price. There is only one basis for a price: a point of agreement between buyer and seller, decided upon by the judgments of the human mind as an extension of subjective human desires. This is true even with programmed trading, since it is humans that must do the programming.
It’s a given that every buyer wants to pay nothing and every seller wants to be rich on one trade. Neither can get his or her way. Finding a point where both parties can benefit from the trade, giving up less than he or she is getting, is the whole point of markets. Prices we propose and accept today reflect information about completed trades from the past corrected in light of what we expect in the future.
The price reflects human judgments, and can, therefore, be said to be a carrier of information about what people believe about their current and expected needs. When we speak of a market price, known by anyone with an interest, we can regard it as an institution that conveys knowing about desires weighed against the availability of the thing desired.
That is a hugely important piece of information to which society has access. It permits efficient use of resources and builds an economic system that serves everyone. “We must look at the price system as such a mechanism for communicating information if we want to understand its real function,” writes F.A. Hayek.
Maybe you read this and thought: no kidding. Everyone knows that. Not so. We can look at the writings of the ancient philosophers and find that they didn’t really understand it. Aristotle articulated the prevailing view that the right price is one in which value is equal on both sides of the trade. But this equivalence standard doesn’t make sense. If you are getting exactly what you are getting, there is no point to the trade. This equivalence theory is actually pernicious because it treats markets as pointless exercises, stuff moving here and there and changing hands for no particular reason.
As modern finance grew more sophisticated in the late middle ages, new theorists got involved in trying to theorize about prices. In times when moral theology was the queen of sciences, intellectuals like St. Thomas Aquinas postulated that a price needs to reflect the needs of justice. In his writings, there is some ambiguity, so that the just price was not necessarily the same as the market price (a mistake corrected over the centuries). This is a deeply dangerous view that gives rise to regulators, moralists, and ecclesiastical nobility who stand in constant judgment over what people are themselves deciding.
Centuries later, new theories of price emerged. Maybe the market price embodies the labor that it takes to produce the good or service in question. This view became the prevailing view in the classical period, and eventually gave rise to the Marxian position that workers – because they are the real value creators – were not getting their fair share of value out of the capitalist system. Indeed, they are being exploited.
This theory doesn’t hold up, however. I can spend the rest of the week making sand castles and work harder than I ever have in my life. That work alone does not cause the products of my labor to thereby become valuable. A buyer doesn’t care in the slightest bit how much labor time or sweat went into making a product. It is either valued or not. A billion-dollar idea can occur to you in one minute or take years to emerge. What matters is not the time you spent but the resulting idea.
A related theory says that prices reflected not only labor costs but all the costs of production. The higher the costs, the higher the price. This slipshod view finds some basis in empirical reality. It is harder to make a Maserati than a Honda Civic, so surely this is why the fancy car is so much more expensive. In fact, this reverses cause and effect. The reason the producer of Maseratis is willing to expend the resources necessary to make them is precisely because markets have shown to value the results. It’s price that determines the costs that producers are willing to bear, and not the reverse.
In more modern times, there are all kinds of rule-of-thumb theories concerning financial markets. Stocks are said to be overvalued or undervalued based on underlying values of the issuing companies. You should look at assets, product development, consumer sales, debt loads, and prospects for the future. Combining all these factors can give you a rough idea of whether a stock is priced too high or too low.
This theory is great except when it is not. As we’ve seen this year in conventional financials, everything has fallen, suggesting that everything was overvalued. Those who predicted the sell off will tell you that they had a perfect understanding of where we were and where we were headed. They will throw out their models and claim to have special insight. But once thing we should have learned over the last fifty years is that no model can predict perfectly, else we would have found it by now, everyone would be using it, and no one would ever lose money.
Every technical model falters on the same grounds: the future is uncertain. No computer is able to overcome the terrible reality that seeing into the future is always a matter of seeing through the glass darkly, as St. Paul said
There is a constant temptation to deconstruct a price into its constituent parts, and posit those as the real basis of price. This is especially true with cryptocurrencies. Bitcoin has shown itself to be a poor performer as a means of exchange; it is too slow and too expensive when it attempts to scale. Nor has it been a reliable store of value. How can a high price be justified? Well, in this case, the source of its value might be as a final settlement layer of the blockchain. What’s the value of that? That is for the market to discover; it might be low or it might be much higher. We just do not know.
The value of crypto is determined by its use value to the human community, and the price represents an estimate of how that value translates into real trades. Finding the right price is a discovery process.
Let’s return to the initial contention drawn from the work of Carl Menger. A price is a point of agreement. No more, no less. It cannot be deconstructed. It cannot be understood apart from human choice. It has no moral component to it at all. It is not about equality, justice, labor, or cost. It is just a price. Every price in a market is the right price, right now. Whatever the price is in an hour, day, week, or year, is also the right price.
Does that sound scary? Maybe. The only thing scarier is a world without prices at all. Think about every experiment in controlling or abolishing them. The results are never good. The purpose of prices is to reveal truth insofar as it can be known at all, however imperfectly. Prices provide us tremendous insight into data we need to know about the world around us, helping us to navigate an otherwise chaotic world.