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The End of Markets, Part I – Jeff Nielson

by Jeff Nielson, Sprott Money:

Readers in the Alternative Media may have noticed a distinct drop-off in the number of articles that are published on “the gold market” or “the silver market”. This is true even with respect to precious metals commentators.

There is a very good reason for this. We no longer have markets. To prove this assertion, as always, the place to start is definition of terms.

What is a market? There are a number of ingredients in any definition. However, first and foremost, a market is a forum for human commerce – person-to-person buying/selling of merchandise and services. By this definition alone, we clearly no longer have markets, on any national or international scale.

A market is some setting (physical or virtual) established explicitly as a meeting place for buyers and sellers. The purpose of markets is improved efficiency in commerce. This greater efficiency comes in several forms.

To begin with, by having a publicized and prearranged focal point for such commerce (a market), we maximize the number of participants. In turn, this provides a number of spin-off benefits.

People minimize the amount of time they need to devote to the day-to-day purchases which are required in order to meet our basic needs, through being able to shop in a single venue – designed for larger numbers of shoppers. The “supermarket” acquired its name because the ability to purchase all of one’s food items from a single vendor was seen as an enormously useful gain in efficiency.

Having large numbers of buyers for any particular market produces an additional efficiency. When large numbers of transactions start to take place in any market, one of two things usually starts to happen. The inventory of that vendor begins to decrease at a faster-than-expected rate, or it begins to decrease at a slower-than-expected rate.

The vendor has a desired target for sales and a limited inventory. If the inventory falls rapidly and the vendor senses strong demand, that vendor raises the price. This is done to capture the maximum price for that product while still meeting the desired sales target.

Conversely, if the vendor senses weak demand because few purchases are taking place and the inventory is falling slowly, the vendor lowers the price of that product. The lower price entices more buyers and the vendor still attempts to capture the maximum price for that product while (hopefully) continuing to meet the sales target.

This self-adjusting feature of markets is called price discovery . As several rounds of commerce take place in any market, both buyers and sellers acquire a better sense of the true price for that product: the price at which the demand from buyers is equal to the sales target of the seller.

In economics, this true price is known as the equilibrium price, for obvious reasons. When supply meets demand, that market is stable. Buyers and sellers become accustomed to the equilibrium price and that price will remain in effect unless/until the parameters for that market change.

For example, if a vendor is a producer (farmer) of wheat and a late winter frost causes damage to the crop, the vendor’s supply of wheat is diminished. Either the vendor raises the price (to maintain a constant inventory level), or the inventory of wheat is depleted, when buyers want to purchase more wheat than is available – at the previous equilibrium price.

These fundamentals are symmetrical, so the reverse is also true. If a wheat farmer enjoys ideal growing conditions and produces a bumper crop, then that farmer needs to lower the price for wheat or else the farmer ends up with an excess of inventory. Naturally, fundamentals can also change on the demand side, with identical dynamics.

The normal condition for human markets is equilibrium. As populations grow and societies evolve, our markets have become larger and more sophisticated. Supply/demand fundamentals tend to balance more readily, meaning greater price stability in markets.

This is what is supposed to happen , in legitimate markets, over any longer term time horizon. Economics has a term for legitimate markets; they are called “free markets”. In order for any market to be a free market, there is a long list of conditions, all of which must be true.

Only a free market will efficiently produce a legitimate price for any product , genuine price discovery, and thus price equilibrium. In order to prove that we do not have free markets (and thus do not have legitimate markets), only the two most important conditions need to be discussed.

Read More @ SprottMoney.com

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