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Wednesday, 26 October 2011

Back to the Mighty Markets

The Morning Posting
Though the media are still saying that the European Union and the Eurozone are under all sorts of threats from 'the Markets', the immediacy and seriousness of the threat is being downgraded. Back in prehistory Harold Wilson said  that "a week's is a long time in politics": and time seems to be moving more quickly in this century. Commentators have not stopped mentioning the fact that 'markets' are a major source of pressure on the politicians and their advisers as they forgather again in Brussels; but they have been forced to respond to the demand of their readers and listeners for the nature of the threat to be specified. The press and broadcast commentators have begun to admit that the risk is not from 'markets' as such, but from individual users of and traders in financial instruments who tend to pursue a form of herd behaviour.

Throughout economic history there has been a series of 'bubbles' when far more investors have offered far more money than has seemed sensible after the event, for 'assets' that suddenly seem so attractive that almost every investor wants a slice of them. Nineteenth and Twentieth-century History regarded as absurd the boom in shares of ownership of black tulip genetics in seventeenth-century Holland: but it seems slightly less absurd today when it can be viewed as a 'false dawn' of the modern capabilities of genetic engineering. No doubt, there will be future bubbles in shares in businesses that make breakthroughs in the application of genetic science. Early in the eighteenth century, even though Scotland had already experienced a boom and a horrible bust of shares in a company for colonisation in Central America, the whole of the now-United Kingdom experienced a huge bubble in the value of shares in the South Sea Company. People who bought the shares early and then sold while the market was still rising made fortunes. Then far more people found their family nest-egg of gold or silver coins, or sold assets to get cash, which they became desperate to spend on shares: so there appeared people willing to create companies in which they sold shares - even including a company 'whose purposes will duly be disclosed'. Suddenly someone recognised that most of these companies had no real assets: some had paid dividends out of the money shareholders had given them, but there was no evidence that they would yield dividends even for a couple of years. The most percipient few investors were able to sell the shares for at least as much as they paid for them, but then more and more people tumbled to the truth and sought to sell: a sales panic ensued and most of the new companies vanished. The South Sea Company survived, in a much diminished state; then over the decades the lesson was shelved. The nineteenth century saw a succession of 'railway booms'  as that technology spread around the world; Brazil had a 'rubber boom' [ended when Brits stole rubber genetics and installed plantations in Malaysia and Ceylon]; and the twentieth century had alarming stock-market booms and crashes. The dawn of a new millennium brought the dot-com bubble, and then followed uncontrolled expansion of a huge range of financial instruments which inevitably led to the greatest crash of all.

In every case the markets in which assets have been sold were simply media: the booms and busts were caused by the human psyche. Economists and journalists have written extensively about 'sentiment' and 'animal spirits', which was wholly appropriate: they also wrote about 'market sentiment' which was absurd.A major complicating factor is the fact that investors' optimism or pessimism is influenced strongly by cheerleaders: media commentators, 'analysts', rating agencies, Central Banks' statements and actions, government policy, opposition warnings and the lucubrations of Warren Buffet and other 'sages' or 'gurus'.

Market participants' behaviour could become so irrational that they sold Euros or Italian Government Bonds regardless of how much of the purchase-price they had lost, ignoring the fact that Europe is more than rich enough broadly to maintain the exchange rate of the Euro against the US Dollar and the Yen; and Italy is rich enough to unwind any perceived excess of government debt over a period of years. Any such asset-sellers would hurt the funds for which they are responsible, perhaps irreparably. Thus it is in their interests to preserve the medium-term 'value' of their holdings. As long as the Eurozone governments can show that they have the capability of maintaining medium-term assets-in-being [having dumped Greece, which is an unsustainable basket-case] they do not need to assemble trillions of dollars-worth of cash-on-the-table today. So they won't pile the cash up pointlessly: they don't need to. Markets have nothing to do with it. Market participants need strong nerves and common sense, and if fund managers should begin to behave destructively their employers should get rid of them - without any bonus or severance packages beyond the statutory minimum.
Evening Posting
After this afternoon's  European Union 'summit' meeting no mighty new bail-out fund has been created, no immediate step has been taken towards 'fiscal union' of the Eurozone, and Italy has been forced into a humiliating promise to retrench further than had been intended by the busted Berlusconi government. The crunch on Greece is still being prepared; and there may yet  be weeks of chatter before the banks are softened-up sufficiently to take the write-down of Greek state debt that will be necessary whether or not some means are found to keep Greece in the Euro The German Parliament has accepted a minimalist proposal from the Chancellor, who is far more concerned about German public opinion than she is about relations with France [though her speech this morning bizarrely referred to a threat that there could be a return to the era of wars in Europe if the EU should collapse].
After this evening's non-news had broken the immediate reaction of participants in 'the markets' was to raise stock prices a little. The politicians have made it clear that they are concerned to preserve the Eurozone: but are nowhere near panicking: they would not be stampeded into the sort of measures that US politicians [in particular] have been demanding from them. The eurorats' favoured technique of proceeding at snails'-pace towards consolidation of all power and wealth in their own hands has worked again.

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