Full text: The Problem of Capital Intensity

THE DISPERSION OF EXPECTATIONS IN A SPECULATIVE MARKET. 
It may be assumed with some plausibility that the participants in 
a speculative market - for example a market for bonds or for 
foreign exchange - have different expectations with regard to the 
future price, or the direction in which prices are going to 
change. 
Contrary to some opinions this diversity of expectations is a 
condition for the attainment and maintenance of equilibrium in 
these markets. ; it must be fulfilled in order to assure that an 
additional offer coming from outside will find buyers or that an 
additional demand coming from outside will will find sellers. A 
further condition is that there must be a generally accepted idea 
of a normal price level to which prices ultimately tend to return. 
This normal price will be a range of prices rather than one single 
price. Though the estimate of this range of prices may not be 
uniform either,it is much more uniform than the earlier mentioned 
price expectations: It must have some basis in objective facts. 
Thus in the case of a manufactured good there may be some general 
information about the range of costs. In the case of an exchange 
rate there is - or at least there used to be - an idea about 
purchasing power parity or relative cost, although in our times 
this has obviously become more and more an obscure and irrelevant 
quantity. In the case of the long term rate of interest there used 
to be a historical experience that it rarely goes outside a 
certain range,but again this "basis in fact" has become more and 
more shaky in view of the violent fluctuations of modern capital 
markets.The undermining of concepts of normalcy in certain markets 
has been accompanied by great instability, so that it does not 
contradict but rather tends to confirm the rule that generally 
accepted ideas of a standard of normalcy are necessary in order to 
maintain more or less stable markets. 
The different expectations of participants in a market could be 
ordered in the form of a frequency distribution (see figure 1 ).It 
will be the distribution of expectations in a market according to 
expected price. In the case of a market in long term bonds let us 
assume in the first instance that each of the participants has the 
same amount of financial resources which he can either invest in 
bonds or hold as cash ( or treasury bills ). We can draw a 
cumulative distribution function showing the number of people who 
expect a price equal to or lower than p, say B(p).These people 
will hold money if the ruling price is p, while all the others, 
(1 - B(p)), will hold bonds. If now a buyer from outside the 
market (let us say from abroad) enters the market with the 
intention of buying a certain amount B of bonds then he will 
have to offer a higher than the ruling price. The new price p’ 
will be just high enough to turn a sufficient number of bulls into 
bears so as to satisfy the additional demand of the outside 
buyer.The underlying assumption is that the people who expected 
prices between p and p’ are now, when the price has become 
p*,still sticking to their belief that prices will not maintain 
themselves at the new level but go back to the old level again. In 
other words the underlying beliefs are conservative. This, it 
appears is a condition for stability. If instead of the implied 
negative feedback of price movements on expectations ( which acts 
like a controller ) there is a positive feedback then the price 
movement whether up or down would never come to a halt.
	        

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