Random Thoughts

In markets, where price discovery is ongoing in perpetuity, two types of corrections exist. Correction by price and correction by time. 

Prices of assets, or anything for that matter, fluctuate to reflect the continuous flow of information. When some market participants in their collective wisdom perceive negativity over the horizon, they get more aggressive in cutting prices, and prices move lower. In extreme cases, they could crash. Case in point - Nasdaq index, which tumbled from a peak of 5,048.62 on March 10, 2000, to 1,139.90 on Oct. 4, 2002, a 76.81% correction. Regardless of the magnitude, the key aspect is this. Markets empower participants to express their opinions about surrounding economic conditions via prices. A new price reflects the state of affairs, real or perceived, and that price is critical in aiding economic actors in their decision-making. 

Sometimes prices are not allowed to decrease, or an efficient price discovery lower is absent. Then, a correction by time occurs. What it means is that the price remains artificially high over a prolonged period. One cause could be a lack of short-selling in a particular market. For example, real estate is not an asset one can sell short. Another example is the unwillingness to accept loan losses and perform markdowns. The ramifications of this are more severe. Market pricing mechanics are abandoned, to save face or for other cultural or political reasons. Financial institutions issued these loans are now sitting on collateral which no one knows the price of, but everyone suspects the reported prices are a mirage. Lack of credit creation follows. Without it, businesses will have a hard time financing operations and funding expansions. Depending on the dynamics of negative credit creation, the economy enters a recession or a depression. This is and was a prevailing cultural phenomenon in China and Japan respectively. 

Arguably these two approaches exist beyond the domain of markets. Extend and pretend strategy is a form of correction by time. It could occur in business or personal relationships. One way or another, it is often based on hope and the inability to face reality. When leaders engage in it, entire societies could pay the price.

A fail-fast culture, cherished by startups, is a form of correction by price. Mistakes are discovered, losses accepted, lessons are learned and adjustments are made quickly. This attitude is emblematic of American culture. This is why I'm so skeptical about China's domination. Just ask Japan.

#AmericanDynamism
April 2024

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146 viewsedited  Apr 9, 2024 at 18:23

In markets, where price discovery is ongoing in perpetuity, two types of corrections exist. Correction by price and correction by time. 

Prices of assets, or anything for that matter, fluctuate to reflect the continuous flow of information. When some market participants in their collective wisdom perceive negativity over the horizon, they get more aggressive in cutting prices, and prices move lower. In extreme cases, they could crash. Case in point - Nasdaq index, which tumbled from a peak of 5,048.62 on March 10, 2000, to 1,139.90 on Oct. 4, 2002, a 76.81% correction. Regardless of the magnitude, the key aspect is this. Markets empower participants to express their opinions about surrounding economic conditions via prices. A new price reflects the state of affairs, real or perceived, and that price is critical in aiding economic actors in their decision-making. 

Sometimes prices are not allowed to decrease, or an efficient price discovery lower is absent. Then, a correction by time occurs. What it means is that the price remains artificially high over a prolonged period. One cause could be a lack of short-selling in a particular market. For example, real estate is not an asset one can sell short. Another example is the unwillingness to accept loan losses and perform markdowns. The ramifications of this are more severe. Market pricing mechanics are abandoned, to save face or for other cultural or political reasons. Financial institutions issued these loans are now sitting on collateral which no one knows the price of, but everyone suspects the reported prices are a mirage. Lack of credit creation follows. Without it, businesses will have a hard time financing operations and funding expansions. Depending on the dynamics of negative credit creation, the economy enters a recession or a depression. This is and was a prevailing cultural phenomenon in China and Japan respectively. 

Arguably these two approaches exist beyond the domain of markets. Extend and pretend strategy is a form of correction by time. It could occur in business or personal relationships. One way or another, it is often based on hope and the inability to face reality. When leaders engage in it, entire societies could pay the price.

A fail-fast culture, cherished by startups, is a form of correction by price. Mistakes are discovered, losses accepted, lessons are learned and adjustments are made quickly. This attitude is emblematic of American culture. This is why I'm so skeptical about China's domination. Just ask Japan.

#AmericanDynamism
April 2024

BY Random Thoughts