This is
why the prices of industrial goods are less volatile than the prices of
shares, or commodities.
But why are stocks and exchange rates volatile to start with? Why don't
they follow a smooth evolutionary path in line, say, with inflation, or
interest rates, or productivity, or net earnings?
To start with, because economic fundamentals fluctuate - sometimes as
wildly as shares. The Fed has cut interest rates 11 times in the past
12 months down to 1.75 percent - the lowest level in 40 years.
Inflation gyrated from double digits to a single digit in the space of
two decades. This uncertainty is, inevitably, incorporated in the price
signal.
Moreover, because of time lags in the dissemination of data and its
assimilation in the prevailing operational model of the economy -
prices tend to overshoot both ways. The economist Rudiger Dornbusch,
who died last month, studied in his seminal paper, "Expectations and
Exchange Rate Dynamics", published in 1975, the apparently irrational
ebb and flow of floating currencies.
His conclusion was that markets overshoot in response to surprising
changes in economic variables. A sudden increase in the money supply,
for instance, axes interest rates and causes the currency to
depreciate.
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