Get used to it: in today’s dysfunctional investment landscape, most risk is, at bottom, government risk.
Two stories illustrate this neatly: the threatened shutdown of or default by the US government and the Keystone Cops-style slow-motion disintegration (or not) of Italy’s governing coalition.
Taking a step deeper, the amazing thing about both situations is that the principal counter-weight to terror in the markets is also government, namely the Federal Reserve and the European Central Bank, both of which are busily writing investors insurance against government malpractice.
If the Fed had not held off on the taper, which it said it did in part because of fears over the budget negotiations, the markets would be taking a far less relaxed view of events.
We are, however, well and truly out of the period (which ended with the crisis) in which we kidded ourselves that somehow the logic and dictates of globalization would keep public policy on narrow ‘pro-market’ tracks.
Similarly, had the ECB not undertaken its “whatever it takes” policy in support of the euro last year we might conceivably be worrying about the new Italian lira rather than fretting over the considerable selloff in euro-denominated Italian bonds.
The balance of forces in financial markets isn’t so much between government and private enterprise as between the elected and un-elected parts of government.
The US Congress was locked in a highly partisan deadlock on Monday, hours away from a shutdown of the US government, as Republicans continued to insist on delaying Obamacare as a condition of agreeing to a funding measure.
Financial markets weren’t pleased at the prospect, which would result in the indefinite suspension of many Federal tasks and services. The dollar and U.S stocks both fell as investors grappled with the move, which would hit growth and confidence.
Moody’s Analytics estimates that a two-week shutdown would shave 0.3 percentage point off of fourth-quarter U.S. growth, which otherwise would be 2.5 percent. A four-week suspension would reduce growth by 1.4 percentage points.
Far worse is the potential that the two sides are unable to agree a bill to raise the government’s borrowing authority, which if not done by mid-October would force a ‘partial default’ on U.S. debt obligations. As the market never recognizes any default as ‘partial,’ that would be an extremely dangerous and destabilizing event.
Central bank put
Political developments in Italy were similarly market-moving, and similarly farcical.
Conservative leader Silvio Berlusconi withdrew support for the government of Prime Minister Enrico Letta, throwing into doubt its ability to survive and sending Italian stocks and bonds lower. That many see Berlusconi’s move, which he advertised as being about a sales tax increase, as a cynical attempt to improve his bargaining position in his personal legal problems did not help to dampen volatility.
Reports of a potential rebellion by members of Berlusconi’s party reversed some of the market moves.
But what really helped, and hugely damped the potential that Italian disorder would spread to the bond markets of other euro zone countries, was the existence and policies of the ECB, which almost single-handedly put the euro project on a more stable footing last year with its open-ended pledge of support.
Things are pretty much the same in the US, where asset prices, if not the actual economy, are pretty effectively supported by what is known as the Fed put, the conviction among investors that the Fed will cushion whatever blow reality might throw.
Perhaps most hilarious, or disturbing, of all is the possibility that Friday’s US jobs report might be delayed because of the shutdown. That leaves the Fed in the position of continuing to buy bonds because the government shutdown denies us the information governing whether the Fed should continue to buy bonds.
So, the risks are from the government sector, and so are the remedies, and both seem increasingly unmoored from any underlying economic reality. Heck of a way to allocate capital.
This is not at all to say that there was once a time when markets valued and funded companies and undertakings without government playing much of a role. Government, the analysis of what it might do and the influencing of its actions, have always been a major factor in the economy, and of investment and financial markets.
We are, however, well and truly out of the period (which ended with the crisis) in which we kidded ourselves that somehow the logic and dictates of globalization would keep public policy on narrow ‘pro-market’ tracks.
That was an illusion, and a dangerous one, because it pre-supposed a sort of one-way flow of history in which government just needs to ‘get out of the way’ and allow the market to do its job.
As we can see, government never did any such thing, as the market amply demonstrates right now.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)