Course: Internation Art Markets
Lecturer: Liesbeth De Strooper
Student: Sam Julio Fortes Neves 373043
Assignment 1 Revised: Essay Art and the Economy
Date: 29 – 03 – 2017
A Bubble always bursts
Introduction.
This essay focuses on the relation between art and the economy, specifically on the contemporary art bubble. Kräussl, Lehnert, and Martelin (2014) have conducted research wherein they examined more than a million auction records spanning over 36 years. Kräussl, Lehnert and Martelin (2014) made a conclusion stating the following:’’ The international art market was overheating, creating the potential of what they called a ‘severe correction’ ‘’ (Helmore, 2016). This was for mostly related to the post-war -, contemporary-, and American segments. In This essay I want to engage in the discussion regarding how the contemporary art bubble got inflated, and if this also relates to general patterns (trends) in other financial markets.
The discussion.
As defined by Helmore (2016) Bubbles in the market are fore mostly defined by an escalation in the capacity of trading in assets. This happens because the prices exceed their base value, what eventually will result in a collapse (Helmore, 2016). ‘’These bubbles are constituted by rational expectations. These rational expectations are often brought up by speculators, who anticipate on the course of the market. This chain of logic eventually puts the base value of the particular asset, equal to the correlating flow of cash (Kräussl et al., 2014, p. 2). This is exactly the case in the events concerning the contemporary art market, which inflated to an unforeseen altitude. Continuously raised expectations, by means of speculation, regarding the value of the assets until the bubble ‘’unexpectedly’’ collapsed. What followed was that the assets completely devalued which led to bad auction sales etc. In the case of most financial assets, it should be relatively easy to define its given value (Helmore, 2016). For instance, through indicators as dividends on stocks (Helmore, 2016).
When taking works of art as a starting point, returns can rarely be correlated to costs made by producing it (Helmore, 2016). Because of the lack of base value concerning works of art, it is difficult to apply standardized economic principles to them (Helmore, 2016). Even still do the markets attempt to influence the outcomes by intense financial speculation and self-produced prices (art dealers, galleries who stimulate this phenomenon).
According to Goetzmann (1993), it is the subjective nature of aesthetic valuation that suggests, that the only constraint that could eventually limit the price of a work art would be the financial wealth of the collectors who’ll have the desire to have it in their possession. To put in other words it means that the price of an artwork is dependent on the demand side. And the wealthier the potential buyers are the higher you can set the price. Goetzmann (1993) also demonstrates’’ that the art prices have met an unprecedented growth’’. ‘Also, does Goetzmann (1993) explain in the article, that even with this growth there is still not enough empirical evidence to back the matter if an investor sees art as a lucrative investment (Goetzmann, 1993, p. 1375). The subjective nature of art makes art a very uncertain market and hard to predict its trends, because of its often heterogenic nature. Especially when it comes to post-war, and contemporary art. Because of its limited supply and high demand, the speculated prices were set on such a high level that is was not feasible to sustain the actual performance of these works art. ‘’This has happened before with the old masterpieces that caused a smaller, but what was nevertheless, a market bubble’’ (Mei; Moses, 2002, p. 1656-1668).
The investigation made by Goetzmann (1993) was primarily focused on the relations between assets in the financial- and the art markets. These relations have effects concerning individuals and a variety of institutions (Goetzmann, 1993, p. 1375). According to Goetzmann’ (1993) analysis, are these institutions the ones to hold a ‘significant’ proportion of assets in art, creating a portfolio that could reduce the volatility of a made or future investment. A frequent finding is that these institutions often try to reduce volatility through these aforementioned ways. Therefore, it is safe to say that they are well aware of this demand uncertainty in the market. Or even try to make the demand uncertainty their advantage.
Mei and Moses (2002) have analysed two major obstacles in analysing the art market. The first is the heterogeneity of works of art, meaning that artworks are valued for their originality (Mei; Moses, 2002, p. 1656). Secondly, people who have works of art in their possession, are not frequently trading in them for diverse reasons (Mei; Moses, 2002, p. 1656). As early as the 1960’s do economists like William Baumol start taking in consideration that art can be regarded as a financial asset (Kräussl et al., 2014, p. 3). Not only did economists and several scholars like Baumol take notice of this, the art market has gained the attention of financial institutions, even those of great scale (Kräussl et al., 2014, p. 3). For instance, institutions as Credit Suisse, Deutsche Bank, and UBS provide advice concerning art to the wealthiest of their clientele (Kräussl et al., 2014, p. 3). Some of these financial institutions provide coverage or loan’s to stimulate the market and the guarantee’s provided by the auction houses, despite the risk-averse investments. Thus, try to cover the infrequent use of trading.
The problem at hand in the contemporary art bubble is that the various institutions (e.g. museums and galleries) and individuals (e.g. art dealers and the artists) regard the works of art as a financial asset (Kräussl et al., 2014, p. 3-4). This creates the option to trade to those who value the work of art as a financial asset, what is an apparent feature in ‘standard’ financial markets. Thus, trying to give something which in essence does not have a base value, a speculated value. This often leads to inconsistencies in the pricing of the artworks and it often varies in between under- and over pricing, because they produce their own prices.
In their analysis Kräussle, Lehnert and martelin (2014) made an equation concerning the base value of an asset and the correlating expectations of cash flows. And that it is easy to obtain the expected cash flows because you then become a shareholder of stock (Kräussl et al., 2014, p. 3-4). When applying this to ownership of a work of art, you cannot claim for monetary returns, but still can experience aesthetic pleasure (Kräussl et al., 2014, p. 3-4). Also, because a work of art does not have a ‘fixed’ value because it is susceptible to devaluation or over valuation, provided by subjective aesthetic judgments.
Mei and Moses (2002) have analysed two propositions, very often provided by involved economists and dealers of art. Firstly, addressing that investors in works of art should buy only the best works or the most expensive one of already established artists (Mei; Moses, 2002, p. 1656). The second given proposition addresses the matter, that if identical paintings are sold at different locations at the same time, they should have the same price (Mei; Moses, 2002, p. 1656). Various researchers like Pesando (1993) have identified that the ‘’law of one price’’ has been violated several times what resulted in an imbalanced ratio concerning the art market.
Mei and Moses (2002) have made several discoveries that are related to the art market. Such as the discovery that works of art underperforms stocks, but is regarded as a more glamorous investment in comparison to some fixed income securities (Mei; Moses, 2002, p. 1666). Which is not a very astounding result, when taking in consideration that stocks always have a direct financial asset whereas art can differ. Because there are people who collect the works of art purely for the aesthetic pleasure as some see it as trade commodity or investment. Also, does their study show results of strong evidence that masterpieces underperform their correlating expectations, which are often the most expensive ones according to the art market index (Mei; Moses, 2002, p. 1666).This stimulates the inflation, with the influence of the economic crisis what also caused the bubble to collapse. The performance of the artwork could not meet up with its expectations. Which in turn led to a loss of investors which is one of the reasons why the value of the masterpieces deteriorated, in the first place. ‘’Third, there is mixed evidence that the ‘law of one price’ is violated in the New York art auction market ‘’ (Mei et al., 2002, p. 1666).
Conclusion
‘’Several findings prove that one of the catalysts concerning the matter why the contemporary art bubble was relatively bigger than other bubbles situated in other markets, was because it solemnly consisted of credence goods. The important characteristic of credence goods is that its utility impact is impossible to ascertain for an ordinary consumer (Emons, 1996). The one who has produced or is willing to sell the particular credence good knows what utility impact the work of art entails, thus consciously creating asymmetric information, leading to inaccurate price speculations (Emons, 1996). This is one of the many reasons that can cause a market bubble. Because this speculation which often cannot be backed up by the actual worth of an artwork, leads to an unsustainable increase in price which does not meet the demand that results in a collapse.
Sagot- Duvaroux (2010) also underlines the notion of ‘’the uncertainty that surrounds the quality of the contemporary artworks on the functioning of the market’’. A form of uncertainty which ‘’resolved’’ by speculation. Another Reason is the non-transparent almost obscure nature of the art market, who do little to not conforming, to the set regulations and restrictions when engaging in the market. For instance, the law of one price (Mei et al., 2002, p. 1666). Even when it is clear to notice that the art market resembles the general financial markets in many ways. There are evident dissonances regarding the fact that it consists of hard to measure prices or standards of quality. For instance, prices of the same work should not have a significant difference, but still, this was sometimes the case. And last but not least of having an imbalanced ratio when it comes to the supply side not meeting the demand side or vice versa.
References
Baumol, W.J. (1986). Unnatural Value: or Art Investment as a Floating Crap Game.
American Economic Review, 76, 2, p. 10-14
Emons, W. (1996). “Credence Goods and Fraudulent Experts”. The Rand Journal of
Economics.
Goetzmann, W.N. (1993). Accounting for Taste: Art and the Financial Markets over Three
Centuries. American Economic Review, 83, 5, p. 1370-1376.
Helmore, E. (17-01-2016). Art Market in ‘Mania Phase’ and Risks Bursting of the Bubble. The Guardian. Retrieved from https://www.theguardian.com/artanddesign/2016/jan/17/art-market-mania-phase- bubble-report.
Kräussl, R., Lehnert, T. and Nicolas Martelin. (2014). Is There a Bubble in the Art Market?
Mei, J. and Moses, M. (2002). Art as an Investment and the Underperformance of.
Masterpieces. The American Economic Review, 92, 5, p. 1656-1668.
Pesando, J. E. “Art as an Investment: The Market for Modern Prints” American Economic
Review, December 1993, 83, p. 1075-1089.
Sagot-Duvauroux, D. (2011). Art Prices. In R. Towse (Ed.). The Handbook of Cultural
Economic.s 2nd Edition (p. 43-48). Cheltenham: Edward Elgar Publishing.