Securities are different from cars, bread, and socks. You don’t buy a security
for the joy of owning it and using it. You can’t drive it, eat it, or wear it. Aside
from getting a dividend or coupon payment, the only reason to buy a security
is to sell it again, preferably for more than you paid for it. Unless you’re a
merchant, you hardly ever buy anything with the idea of selling it again —
except securities.
In standard economic thinking, the law of supply and demand states that
demand for an item depends on its price, which is a function of scarcity. If
something is rare, it’s expensive. At higher and higher prices, demand falls
off. At some point, the high price induces suppliers to produce more of the
thing, whereupon the price falls. Equilibrium consists of demanders and suppliers
finding the mix of quantity and price that both parties find acceptable.
This process is called price discovery, and it can take time.
In contrast, in securities trading, the pricing process is like the pricing process
in an auction. For one thing, prices move a lot faster. Plus, in an auction
(such as the online auctioneer eBay), demand for the item often rises as the
price rises. If you ever participated in an auction, you probably paid more for
something than you should have. But you just couldn’t let the other guy win,
right? Every time someone else outbids you, you want the item more than
ever and become determined to be the winner. The intrinsic value of the item
doesn’t matter.
Sound familiar?
You may even have an object or two in the
hall closet you’re ashamed of having bought at an auction. I certainly do.
In an auction (whether live or online), what gets your blood running is that
someone else also wants to buy the item in question. Visible demand begets
more demand. Auction economics are contrary to what traditional economics
teaches — that demand will decrease as the price rises. In the auction
situation, demand increases as the price rises. The item may or may not be
actually scarce in the real world. It doesn’t matter.
The immediacy of the auction is what skews prices, sometimes to absurd
levels. Later, when suppliers see the high prices, they may indeed be able
to find or produce more of the item — but by then, the specific demand
dynamic of that one auction is gone.
