The creators of the cult US comedy series South Park are best known for
their incisively funny takes on all aspects of American (and global) life. They
have made fun of pretty much everything, ranging from the banking crisis of
2008 (search for "And it’s gone" on YouTube) and various religious groups from
Scientologists to Catholics.
Most recently, the South Park episode featuring a caricature of Prophet
Mohammad was aired only after heavy censoring, as the network (Comedy Central)
received death threats that may then have been put into effect in the failed
bomb plot last weekend when an explosives-laden truck was parked outside the
network's headquarters in New York.
The point is that somewhere along the line, all the fun and games
suddenly stop - and usually when some loon pulls out a real gun. This may well
have happened to the South Park creators last week; but also for the
markets. A number of developments that would have been shrugged off in the
usual course of things have suddenly assumed gargantuan importance in the minds
of investors and created a slide across multiple categories of risk assets.
I can't imagine what the creators of South Park would make of this, but
I genuinely think that even these geniuses couldn't have possibly written a
farce involving the markets better than what has actually transpired over the
past few days. And thus it turns out that you switch off one episode of a
comedy show somewhere in the world and everyone starts role-playing en masse
instead. Yes, there are many possible (and serious) interpretations of what has
just transpired in the markets, but perhaps the easiest way to express opinions
on these is to take the route towards levity.
G-factors
So there is the story of the young Wall Street type who had an awful auto
accident. As he walked out of the crash sobbing hysterically, one of the
passers-by gasped: "Look at your arm, man - it's been cut clean off!"
The Wall Street type replied: "Forget about my arm, man - I lost my Rolex!"
As many a market participant has already noted, there was something about the
letter ‘G' last week in the markets:
a. Greece b. Goldman Sachs c. Gulf of Mexico (oil spill) d. Germany e. General elections (in the UK)
It is a fact that
financial markets tend to trivialize real suffering, crimes and disasters into
a bunch of simple green and red arrows. Then again, that is perhaps easier to
comprehend within the morass of one-sided opinions and hidden agendas that
appear to characterize the financial media reporting of various events.
In no particular order, we have the oil spill in the Gulf of Mexico, which was
initially reported as a leak of "200 barrels of oil" and soon became apparently
a whole lot worse. Immediately, the political overreaction started off with
calls to end offshore drilling in its entirety, and yet others calling for a
resumption of nuclear power (by then, they had forgotten about Chernobyl, well
over 20 years in the past). There is the obvious financial effect on the likes
of British Petroleum (BP), which owned the operation, but also equally on other
companies with significant businesses involving support services for offshore
drilling.
Interestingly, in the days after the disaster, as it became increasingly clear
that future expansion of offshore oil drilling would become more expensive and
restricted, the price of oil fell rather than rose. This is counter-intuitive
when you consider declines in supplies going forward if one assumes that demand
remains constant.
The primary reason was of course that the US dollar strengthened against other
currencies, primarily due to the woes affecting Europe coming from the other
"G" factor, namely Greece. Improvement in the US dollar affects a whole bunch
of "carry" trades that rely on a continuing decline in the value of the
greenback as its future purchasing power is eroded by continued printing; the
counter-effect of asset-price inflation in other words.
When, on the other hand, investors forsake risk assets and start going towards
the putative safety of the US dollar (and US government debt) mainly to avoid
the riskier European government debt, the end result is what you saw in the
markets for the past few days, that is, widening yields on riskier European
government debt, a selloff in the euro, a rise in the value of the US dollar
and a decline in the prices of risk assets.
I have written about insolvent European governments in general and Greece in
particular for the better part of the past three years, so there is very little
for me to add now when speculation has given way to fact - and for good
measure, in much the same way that a Moliere farce takes over a Shakespearean
tragedy in the middle of a first act.
Even though Greece secured a 110 billion euro (US$138 billion) deal with the
rest of the European community and the International Monetary Fund (IMF), a
vast increase from the original figure of 30 billion euros, the market's
reactions on Tuesday (May 4) suggested that the contagion could well spread to
other European economies (Portugal and Spain being the most frequently named),
even as confidence in the austerity measures proposed by Greece to meet the
conditions also proved ephemeral.
Germany, the putative fourth "G" in this equation, has to approve the Greek
financing plan by the end of this week. While this approval does look possible
even against the backdrop of important state elections in the country, the deal
isn't quite done yet. There is much anger within Germany about the "unfair"
standards of public pay and pensions in Greece which many Germans consider as
the root cause of the Southern European malaise. Failure to address this rot
would likely harden German attitudes to future bailouts, and vastly complicate
matters for the current situation.
A wide-ranging public-sector strike in Greece that closed down schools,
hospitals, government offices and various public services on Tuesday couldn't
have come at a worse time (but then again, what does one expect from communists
other than silliness on a grand scale), showing investors that the political
will to impose austerity and thereby reduce the country's structural deficit
would prove, at best, transitory.
As Martin Wolf writes in the Financial Times:
Yet it is hard to believe
that Greece can avoid debt restructuring. First, assume, for the moment, that
all goes to plan. Assume, too, that Greece's average interest on long-term debt
turns out to be as low as 5 per cent. The country must then run a primary
surplus of 4.5 per cent of GDP [gross domestic product], with revenue equal to
7.5 per cent of GDP devoted to interest payments. Will the Greek public bear
that burden year after weary year? Second, even the IMF's new forecasts look
optimistic to me. Given the huge fiscal retrenchment now planned and the
absence of exchange rate or monetary policy offsets, Greece is likely to find
itself in a prolonged slump. Would structural reform do the trick? Not unless
it delivers a huge fall in nominal unit labor costs, since Greece will need a
prolonged surge in net exports to offset the fiscal tightening. The alternative
would be a huge expansion in the financial deficit of the Greek private sector.
That seems inconceivable. Moreover, if nominal wages did fall, the debt burden
would become worse than forecast.
So where does the third "G",
namely Goldman Sachs, fit into all this? Well, among other things that the
venerable (I am only kidding, obviously) institution has been accused of this
year alone is the revelation that it engineered fantastically profitable
currency-swap agreements with the Greek government that helped the government
to reduce its reported debt levels and thereby meet conditions for the
country's early entry into the euro.
Meanwhile, Goldman Sachs is facing possible criminal prosecution for its
various deals related to collateralized debt obligations (CDOs) and has been
encouraged to settle with the US Securities and Exchange Commission in a bid to
stabilize its reputation (see
Goldman and the charade of honesty, Asia Times Online, April 20, 2010).
That hasn't done the firm a whole lot of good - in fact, quite the opposite as
its stock has fallen like the proverbial rock, from US$185 per share at the
beginning of April to just under $150 as of the close of trading on Tuesday May
4. The 13% decline for a month compares to a relatively flat performance for
its closest rival, Morgan Stanley, over the same period (showcasing the
company's woes as different from the general macro trend).
To cap it all, we have the UK general election on May 6, which is widely
expected to lead to a hung parliament (a situation where no political party
achieves majority by itself). While market reaction was phlegmatic in the weeks
before the poll, as investors reconciled themselves to a period of political
uncertainty in the country, the moves in Greece towards sharp declines will
mean a possible reassessment of such risks. In the event that no political
party gets a majority on Thursday, it is possible that a market-wide selloff of
the pound Sterling (GBP) could resume - the currency fell sharply against the
US dollar on Tuesday just due to this possibility.
Perhaps the best instance of levity in the staid world of financial markets
came on Monday, when the European Central Bank (ECB) permanently suspended
rules for the acceptance of Greek government debt as eligible collateral for
refinancing (repo) operations. This means of course that no matter what the
credit ratings of the country, banks holding Greek government debt can continue
to discount the bonds at the ECB window indefinitely - this should in theory
encourage them to continue purchasing Greek government bonds, but in practice
may only have served to point out the foundations of wool underpinning the euro
project.
To wit, I relate a call from a salesman on Monday this week after the ECB
announcement:
John: "Chan, old man, keep all your train and bus tickets when you go
around Europe. Me: "Why would I do that, John?" John: "They are eligible for ECB repo now, aren't they."
In the light of such events, one must consider the possibility, if not simply
admit, that the market movements and global events are being scripted by some
gifted comedians. Stand up for your ovation, writers of South Park.
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