Since the markets are driven by average opinion about what average opinion will be, an enormous premium is placed on any information or signals that might provide a guide to the swings in average opinion and to how average opinion will react to changing events. These signals must be simple and clear-cut. Sophisticated interpretations of the economic data would not provide a clear lead. Hence the money markets and foreign exchange markets become dominated by simple slogans – larger fiscal deficits lead to higher interest rates, an increased money supply results in higher inflation, public expenditure is bad, falling unemployment always leads to accelerating inflation, and so on. For substantial periods of time markets maybe stabilized by convention – everyone believes that everyone else believes that the economy is sound and financial markets are fundamentally stable. But if convention is questioned or, worst of all, shattered by a significant change in beliefs, then the values of financial assets may soar to great heights or collapse to nothing.
To some extent it doesn’t matter whether the simplistic slogans of the conventional wisdom that dominate financial markets are true or false. What matters is that average opinion believes them to be true. Average opinion is reinforced by labeling these beliefs “fundamentals,” as if they were revealed truths. For many years it was believed that the UK balance of payments was a “fundamental.” Any deficit in the current account would result in selling pressure on the pound sterling, as the markets followed their beliefs. In the past decade opinion has changed, the current account is no longer “fundamental,” so deficits no longer produce the reaction they once did.* A “fundamental” is what average opinion believes to be fundamental.
– John Eatwell and Lance Taylor, Global Finance at Risk: The Case for International Regulation, 2000, pp. 13-14.
* The broader point still holds, even if the specific example is less apt than it was in 2000.