The fear of an absence of order
There is a contemporary anxiety afoot which dreads that an absence of regulatory rules would lead to certain chaos, disorder and general peril. Many people are afraid of the spontaneous formation of orders that are unfamiliar to them, especially if they arise through market forces. But whoever has ever set foot in an oriental bazaar or a sprawling Asian marketplace knows that markets which are left to organize themselves amazingly create spontaneous rules and order. Markets always strive toward rules and order, never toward disorder.
The need for additional state regulation is primarily to be suspected wherever market forces trigger external effects that impose costs on the general public. The hazard of external costs – not the desire for more order – thus presents the prime justification for regulatory intervention in free markets. Prudent market regulation should not replace a market’s spontaneous ordering forces, but should instead channel the creative power of liberalism to make markets not less attractive, but more attractive for the general public.
On myths and preconceptions
Despite all of the objective arguments, a certain uneasiness lingers in public perceptions about the financial industry. There are two very widespread myths: one which insists that financial speculation produces price bubbles and supply shortages, and the other which asserts that derivative financial instruments pose nuclear risks to the financial system. With regard to the first prejudice, there is no reason to presume that buyers are always in the majority on the financial markets. Since buyers are on either the winning or losing end of a trade fifty percent of the time on statistical average and the same goes for sellers, price bubbles are in no way the result of increased speculation. On the contrary, the more speculation there is, the more liquid, deeper and broader a market becomes.
The second prejudice against derivative instruments must also be critically challenged. For derivatives enable financial-market risks to be broken down into individual components and allocated in a way that allows investors to bear only precisely those risks to which they are specifically seeking exposure. This feature of derivatives enhances the ability of financial markets to allocate and value risks more accurately. Furthermore, in 2008, it wasn’t derivatives themselves, but rather the opaque way in which they get traded over the counter, that caused the chain-reaction-like spread of the crisis.
Implications for investors: Shares of blue-chip companies
Banks offer little upside potential as enterprises and stock investments in the years ahead. It is unrealistic to expect a speedy return to the prosperity of the last decade as long as recapitalizations, balance-sheet downsizing, a flood of new regulations and tax rules, financial repression and a structural supply overhang continue to plague the banking sector. Shares of blue-chip companies with sound balance sheets, visionary management, strong market positions and formidable pricing power offer the greatest value appreciation potential today. Investing sustainably here means reducing investment risk, enhancing return prospects, and exercising the responsibility that comes with owning wealth.