Yesterday I spent some time waiting at the clinic, and so I read a few more articles in the ‘Oxford Handbook of the Sociology of Finance’ on my smartphone. I was struck by a revelation that occurred when I combined two contributions by Swedberg and Hardie & MacKenzie, leading scholars in the field.

Swedberg has a piece on ‘confidence’. Strangely, economics has ignored this concept, despite the fact that Keynes’ famous ‘chapter twelve’ of the ‘General Theory’ introduces the ‘state of confidence’ as a central causal determinant of investment, even arguing that it directly determines the marginal efficiency of capital. Probably the reason is that Keynes himself did not move further on, so leaving the room for the mathematization of his concepts, thus marginalizing uncertainty.

Now, at the end of the article, Swedberg submits a surprising proposal: Namely, that research on confidence should be based on the semiotics of Charles Sanders Peirce. Well, I am great fan of Peirce, and I used his philosophical framework in my ‘Foundations’ of 2013, continuing with this also in other publications dealing with neuroeconomics. I was not aware of Swedberg’s use of Peirce. The starting point is very simple: Confidence as a complex emotional and cognitive state is triggered, shaped and changed via an economic environment that is entirely mediated via signs. I am now collaborating with a young Brazilian economist, Luis Macedo, who thinks that monetary policy could be analysed by means of semiotics.

Then I read the paper by Hardie and MacKenzie on arbitrage. And the pieces fell together! Arbitrage should be a risk-free activity that only reduces inefficiencies. However, this presupposes that, let us say, the two assets which manifest price differences are the ‘same’ ones. This is a fundamental condition for applying the oldest law in economics that defines the basic mechanism of arbitrage, the Law of One Price. In my earlier work on international trade, I have dealt extensively with this issue, since ‘sameness’ is by no means an easy construct. Clearly, sameness is without any problems if you deal with Forex arbitrage: A US dollar is a US dollar (and gold is gold, if standards are applied correctly).

But this does not apply as easily for many other assets. Hardie and MacKenzie give a fascinating example: The bonds of the Italian government issued at the end of the 1990s. Before Italy joined the EMU, Italian bonds were seen as much riskier that German bonds. But when the perception grew that Italy will join the EMU, both types of bonds were increasingly seen as being the ‘same’, and arbitrage set in, supposedly increasingly free of risk. This had the important effect that the Italian government had to pay less interest, thus stabilizing the budget, which was the precondition for joining the EMU. This is amazing, as we have a clear case of performativity: The arbitrageurs, perceiving the two bonds as ‘same’, made the actualization of sameness possible! The convergence of interest rates among EU countries remained a stable feature until the Euro-crisis broke out and suddenly investors started to perceive the bonds as different.

This is a clear-cut case of ‘semiosis’ determining the ‘state of confidence’. Hardie and MacKenzie even mention that traders actively engage in communicating their perceptions to others to create a certain state of the ‘economic semiosphere’ in which they can conduct arbitrage free of risk. In other words, dealing with uncertainty is not simply about assigning subjective probabilities to certain states, but structuring the state space as such via semiotic actions or semiosis.

I think that semiotics can provide a powerful analytical perspective on how economic agents actively shape the state space of their actions and related outcomes. This is much deeper than mere self-fulfilling prophecy. After all, their actions are always reflexive, and this turns uncertainty in certainty or, calculable risk. Yet, in times of financial crisis this semiotic construct suddenly collapses, throwing everyone back into uncertainty. However, it would be wrong to think that the previous state was a mere illusion, and only the collapse reveals ‘reality’. There is no reality beyond the one created via signs.

References

Richard Swedberg, The Role of Confidence in Finance

Iain Hardie and Donald MacKenzie, The Material Sociology of Arbitrage

In: K. Knorr-Cetina and A. Preda, eds. Oxford Handbook of the Sociology of Finance, 2012.