Rethinking Markets

One of the more taken-for-granted things about financial markets (and as I’m studying fine art, those as well) is the role of public prices in the mobilization of prices more broadly. This has sweeping importance, but I’m not sure a commensurate amount of theoretical attention.

I had a chance to chat with a friend who works in valuation for a hedge fund, and he made an interesting point about art prices and how it compares to securities. He, reasonably, considers anything generating less return than Treasuries as being a net negative cashflow investment. So while a stock is a claim on a company’s future earnings, art requires that its intrinsic value rise for it to be a net positive return asset. Unless you can charge for people to see your art (which you, socially speaking, can not), the insurance and opportunity cost ensures that your investment is negative with respect to Treasuries. This is Nassim Taleb’s contrast of Nero and John in Fooled by Randomness, the bond trader who depends on the certainty of earnings, and the stock trader who depends on the fickle beast of global securities markets.

This is all basic. But it really underscores the assumption underlying all financial markets: that prices can be measured against US Treasury Bills as a baseline. Because US shouldn’t default, this is the effective cost of money. And it is the public nature of that rate of return – that Treasuries are sold at auction, that these results are public – that matters so much to financial market actors.

This leads to two thoughts: 1) without the public prices of Treasuries (or some equivalent), there would be no organized, global financial markets; and 2) organizations engaged in private pricing, of illiquid assets and esoteric derivatives, are parasitic on public prices. There’s something important here, though I’m having a bit of a time putting my finger exactly on how to put it.

In an interview with an Asian art specialist, she noted:

Private sales we do occasionally, but we really want to sell through the auction process…Because, very often today it is difficult to establish the correct price for something. What does that mean, the correct price? What is someone willing to pay for something. You have precedents, but if you are dealing with highly unique works of art, certainly in Asian art that is often the case, but also as we’ve seen in the Impressionist sale a couple of days ago, who would know that someone is willing to pay $80 million for a Klimt? That we don’t know. So, the problem with a private sale is what price should you put on this and what price should you ask for it and who do you ask first of the clients you might have for this piece. So, it’s very difficult.

Sure, Hayak, yep, adverse information gets more easily incorporated into market prices than centralized planning agencies, but it’s also that aggressively private pricing makes it harder for everyone to know not just how much, but also how, to value things.

In the late 19th century, this ‘contribution to public price mechanism’ was the basis for claims against bucket shops, who were said to be gambling precisely because they never really contributed to the important work of pricing commodities. Instead, they were more like wagers on the levels at the CBOT.