The function of finance is to allocate savings to investment and to allow actors to choose the risk-return ratio that suits them.
Investing that temporarily immobilizes monetary savings always carries a risk. Inevitably, some investments fail to deliver the returns the investor expects.
Similarly, among households there are still people who overestimate their future income, but still manage to convince the banks that they cannot repay their loans, for example real estate loans.
A good financial system is required to ensure that all profitable projects at a given price of capital are well financed, thereby maximizing growth.
It satisfies all demand for loanable funds at this price. Therefore, it also necessarily finances companies that will go bankrupt and households that will prove bankrupt.
In no way can the risk be eliminated. There is always a certain number of financial securities that will not keep their promises.
A good financial system therefore inevitably creates a lot of promise about future income. This is why we regularly witness purges where it is eliminated.
It is this cleaning mechanism that ensures the stability of the system. The form of liquidation will depend on financial systems.
Between the Bretton-Woods conference in 1945 and the opening of national financial markets in the 1980s, financial systems were compartmentalized and it was argued that banks were superior to market instruments.
Under these conditions, liquidation essentially took the form of accelerating inflation in prices of goods and services. As we will see, current global market financing is a form of liquidation, inflation in the prices of certain classes of securities, followed by a collapse.
Any rational financial actor should always ask whether each of the securities that make up his portfolio and each of those likely to enter it are overvalued or undervalued. The market price of any financial security is therefore a kind of median.
At this equilibrium price, no one wants to buy or sell. Anyone who thinks the stock is undervalued and rising has more than enough stock to his liking. Others feel that at this price, it doesn't have enough upside potential to buy it.
The vast majority of players feel that the price has correctly evaluated this security, except for a few points that may not be worth portfolio adjustment.
Price therefore reflects a dominant median view of the future of the underlying: the future of a new product, a company, a country, the global economy, etc.
In reality, to have a precise vision of the future of a new product in a particular market, it is necessary to have a vision of all the intertwined futures, from that product to the world economy.
This vision for the future is changing under the influence of the information flow, which financial players are very enthusiastic about. To be more precise, visions are only modified by possible differences between the actual flow of information and the predictions of the information.
Every announcement of an economic outcome that is part of the long-awaited information flow is about what that outcome actually is.
Consensus is already integrated into the price of securities. Only a deviation between the actual result and the consensus changes prices.
But how did these visions form before they were affected at the limits of the information flow?
Investors can evaluate their subjective probabilities by considering the various parts of their product, company, country, world, etc. they do not distribute it in such a way that it equally occupies the entire spectrum of possible futures for
In general, we observe that visions are clustered around a dominant vision.
We can see the effect of rational imitation in financial markets. The important thing is not only to be right, but also to be wrong like everyone else.
The prevailing vision derives from a particular model of interpretation of reality and its dynamics. The new information flow is processed by this interpretive model and changes the prevailing view. But the model itself is usually unaffected for long periods of time.
However, in a very hard to predict way, a set of information regularly appears to undermine not only the dominant vision but also the interpretative pattern that built it.
Very generally, this causes large price fluctuations as the market loses direction.
Then comes a level of stability that, of course, has no reason to be better than the previous one, but reaches the stability of a new dominant view supported by a new model of interpretation.