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Markets that thrive on bad news are damaging for society

The biggest news stories of 2014: Ebola, the rise of Islamic State, Ukraine crisis, tumbling oil prices, terrible growth data in the Eurozone and the US, uprisings in Hong Kong and across the world, growing inequality, turmoil in the Middle East. And also the return of capital markets led by record highs in stock and bond markets. Spot the odd one out.

If markets stubbornly improve as crisis after crisis unfolds around the world, this weakens the capacity of the world to improve itself and correct its problems.

What does the world need to do to meaningfully upset markets? Clearly a stream of weak economic numbers, the Middle East in meltdown following the rise of an unpredictable and barbarous Islamic State, an increasingly bellicose Russia and a killer disease spreading exponentially will not do the trick.

For too long, bad news has been good for markets. Weak data, or market panic, or EM wobbles mean more central bank support. Even now, if the ECB fails to buy enough private sector assets and fails to stem deflation, that means a buying opportunity (because sovereign QE must be on the way).

But if the rich get richer as the world gets worse, an important social purpose of markets is broken. Supply and demand is getting matched, but the signal the market sends to society is malfunctioning. Disaster can continue to unfold and the richest and most powerful in society will little incentive to do anything about it.

Assets, of course, are worth what people believe them to be worth, but the market has little confidence in the brace of recent record highs. When markets began to spiral last week, the terror among market participants was matched only by the thrill of realising that finally markets might be reflecting the world. The perverse incentives and strange acts of will that have kept valuations high were coming apart.

But the reckoning never actually came. Eventually, though, QE and the other supports will be removed, and markets will have to have another stomach-churning glimpse of underlying economic reality. The longer markets continue as though nothing were wrong, and the worse the world gets, the bigger that fall will be. The market needs a clear-out and a purge, a catharsis that can lead to a new renewal.

While developed markets continue to ignore the rich variety of geopolitical and economic crises unfolding in the world, it is hard to argue they are fulfilling all of the functions society might demand. Markets are supposed to connect the pricing and transferring of risk to reality. Once they fail to do this, risks go unheeded and disasters unfold, while world's asset-rich population remain sanguine. 

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