ABSTRACT
The notion of equilibrium is deeply ingrained in the culture of academic economics. Market equilibrium is the benchmark against which real markets are supposed to be measured, and an implicit, unstated assumption of both stability and computability is made. Typical academicians assume uncritically and implicitly that free markets could somehow self-organize into a dynamically stable system and thereby approach statistical equilibrium. A stationary stochastic process would then describe fluctuations about equilibrium. Empirical evidence shows rather that price processes in deregulated markets, left to traders’ actions, are nonstationary. There is no empirical evidence for an approach to market equilibrium, market clearing is not observed. Countries that protect their own industry and currency and if necessary, effectively impose tariffs, know this. But academicians have not realized that a stationary market is not an efficient market. Arrow and Debreu first created the illusion that uncertainty/probability could be banished from microeconomic theory, and Lucas later created the illusion that nonstationarity could be banished from both macroeconomic reality and modelling. We show below that, in contrast with those standards, erroneous ideas, an efficient market is a martingale process, and a stationary process is in conflict with a martingale process. We will provide empirical evidence that current foreign exchange (FX) markets are martingales, to within observational error, after a ten-minute trading time lag. We will focus on the pair correlations of returns necessary to understand the underlying finance market dynamics. Efficient markets and stationary markets generate completely different, conflicting pair correlations. As our first example, we present a case where currency speculation was apparently self-stabilizing as the consequence of stiff regulations. The theme of this chapter can be understood as market stability and inefficiency from regulations, market instability and efficiency from deregulation. We will argue that, compared with the stability observed under the gold standard, deregulation of money has made markets more efficient in the sense that the markets become noisy in a way that makes them hard or impossible to beat, and with great risk.
