Market Manipulation: A Theoretical Approach

by Francesco Carbone, U.S. Equity and Macro Lab. May 18, 2004

Of the wide variety of analysis and independent comments available on the internet, you can happen to find explicit references, or suggestive explanations regarding some sort of presumed price manipulations operated by the so-called "strong hands." In particular, between October 2002 and March 2003, we joined the chorus of voices that claimed the existence of an artificial support applied to the stock indexes so as to avoid a confidence crisis that in a short time could become irreversible.

As a result of the recent price metals plunge, and with particular reference to the vertical drop of silver, similar conjectures have been advanced. They attribute the responsibility of this abrupt movement to those same powers. Unfortunately, the use of conspiracy theories is more than welcomed to all of those victims of market movements occurring in the opposite direction to their expectations. That is what usually happens to investors or traders with a strong ego that refuse to admit their own errors of appraisal.

In order to overcome this mental trap, we would like to face the delicate issue of manipulation using our theoretical base outlined with the article "A Trip to Russia" which assumes the position of the Austrian School of Economics on Socialism. What we try to do is offer a logical reasoning about manipulation, based on the theory, which doesn't refer to any specific case. Practical examples will be offered only later as a support of the same theory, even if not necessary to validate it (validations could only be found in a theoretical way recurring to the long debate on Socialism which, during the 20th century, opposed the Austrian School and many so-called economists).

The starting point of this reasoning is simple and irrefutable: there's no doubt that the interest rates market, by far the most important market in the world, is manipulated by the worlds' central banks who, on the base of their own subjective appraisals, imposes with force, i.e. in a coercive way, a determined interest rate to any economic agent. This is not conspiracy. Even if a person not accustomed to economic matters, with just a vague idea of the free market simply based on the two common words "free" and "market", could find this fact somewhat strange and weird, Central Banks' short-term interest rate manipulation is the key on which any monetary policy is based.

According to the Austrian School of Economics, this kind of manipulation has serious repercussions on the rational formation and allocation of voluntary savings. Under "normal" conditions (i.e., in the absence of a Central Bank) market interest rates, all along the yield curve, will be guided by individuals' time preferences. We leave the detailed examination of this very important issue to further articles or directly to any book of Austrian Economics. What we are interested in now is one simple consideration and its logical implications: the short term interest rate manipulation is a price fixing exercised by the Competent Authority (what an oxymoron!) that causes imbalances on the market.

Let's see what we had written in the last article entitled, "A Trip to Russia: the strategy of price fixing is (temporarily) effective only if ANY sector of the economy is under control." The short-term interest rate manipulation is only the FIRST coercive means the Monetary Authority can use in order to accomplish his goals. From case to case and according to the goal, economic cycle stabilization or economic growth at all costs (where the costs are postponed to a undetermined future), this first manipulation opens the doors to a further wide range of actions. They will be enacted to manipulate other variable ones, or to fix other prices, so as to accomplish the pursued aim.

In case the first short term interest rates manipulation is not sufficient, the progressive control on other variables is necessary. As exposed in the cited article, the path is very clear: slowly it becomes necessary to proceed with a progressive planning of the economic system. No matter what the starting point is, and in spite of the apparent and temporary effectiveness of the economic controls realised, any attempts to plan the economy will lead to "a result opposite to the intentions: economic and civil chaos, as generated by a clumsy tyrant".

Well, following this theoretical guide, it could have been logical to suppose that, in the aftermath of an economic inflationary expansion that had caused not only the greatest stock bubble of all times, but also all a lots of structural economic imbalances, a simple anti-cyclical interest rates manipulation would have not attained any positive effect. That's what happened to the biggest interest rates manipulation of history of mankind for nearly two years. Therefore, more evident actions of manipulation have become necessary. Some of them have been carried out on long interest rates (thanks to special aids by the Bank of Japan) and on the Dollar/JPY exchange rate (rather generously from the Bank of Japan).

There is no concrete evidence regarding the stock market, however, following our reasoning that interventionism requires more and more heavy and extensive actions, is presumable to assume that some supports to the stock market have been carried out between the lows of October 2002 and the lows of March 2003. It is also acceptable to suppose that the main exchange rates are held within mutually acceptable ranges, especially after the market has shown an undesirable attitude to push currency rates towards unacceptable thresholds of pain.

The control realised on some variables sooner or later lead to some price movements which put at risk the effectiveness of the controls already executed. This requires further action of mending. So, it would not be insane to think that lately the metal markets demanded urgent actions, promptly executed. Also, it is presumable to think that an analogous mending will be very soon applied to the oil price, at its all time highs. Following the same logic, the recent deterioration of many stock market indicators, which pushed some analysts to issue a red warning code (crash alert on sight), must have already attracted some special attention. At this stage some support is surely needed so as to deliver the stock market safe and sound to its important fall election.

Resuming the ideas of Étienne de la Boétie, any regime (or in this case, any imposed price system) is always fragile, no matter how much powerful or effective it may seem-- for it cannot be maintained only by coercion. He who imposes his own will (his prices) is indeed in numerical inferiority. Therefore, it’s always necessary to create an opportune climate of confidence, consent, and voluntary disposition to the planned system.

Thanks to this further theoretical help, we are able to explain any kind of statistical massage, for example the 2% inflation (actual inflation to consumers pockets seems to be between 8% and 10%), or the recent brisk labour market, (reading through the lines the 90% of new jobs seems to be the result of changes carried out in composition of the working force). We can also explain the deflationist campaign conducted by the Fed, which was deliberately badly argued. In order to create a climate of confidence, otherwise impossible, the forces predisposed to the planning and the control of the economic system continue to fantasize about a non-existent world in nearly perfect equilibrium that leaves us with the impression to live in an Orwellian world.

In conclusion, the bottom line is that fixing or manipulating a variable unavoidably creates many imbalances that sooner or later demand more and more to diffuse actions directed to manipulate other variables and to fix other prices. This is what probably has already happened and continues to happen in the real world regarding a wide number of market prices. The markets, affected by this massive intrusion, seem to have lost not only any logic, but also their fundamental function: regulate, in the proper way, the complexity of human actions.

Although this phenomenon is not yet perceived, we already find ourselves on the threshold of a chaos destined to degenerate towards an increasing disorder. It might be that people still don't realise, or they just prefer not to notice, but the shack held together solely by manipulation lacks the foundations in order to stand by its own. Any economic system without a free market sooner or later is destined to fall before the shocked faces of its manipulators, in the same way the Soviet economy, which was thought to be stable and solid like a rock, abruptly fell apart.

Contact Information

Francesco Carbone | Madrid, Spain | US Equity & Macro Lab | E-mail

Disclaimer:
The above is a matter of opinion and is not intended as investment advice. Individuals should consult with their broker and personal financial advisors before engaging in any trading activities.