Securities markets have witnessed some extraordinary disorder in recent weeks. Back in early May there was the stomach-churning “flash crash” on the New York Stock Exchange, when some as-yet-unexplained disruption triggered a brief but precipitous collapse in US equities. One stock, over the course of a few minutes, literally zeroed out: technically the company’s equity capital vanished. Even a number of large and stable industrial firms absorbed a hit to their stock that seemed unimaginable. Conjecture on the cause of this shock centers around computerized trading models, which operate on complicated algorithms to execute stocks trades in fractions of seconds.
I’m not sure what the current theory is, but for awhile it was thought that someone blundered into a mistakenly enormous sell-order of Proctor & Gamble stock (billions of shares instead of millions); P&G being an major component of thousands of managed portfolios, its sudden drop in value activated automatic sell-offs in dozens of other stocks; and before anyone could blink, billions upon billions in paper wealth was gone. The SEC and other regulators have subsequently canceled many of these trades, but for a few hours there the extreme fragility of finance capitalism was brought home in a brutal way (again) to every trader around the world.
More worrisome have been the persistent dislocations in Europe. The problems there are deeper and more portentous than any algorithmic disruption. The “periphery” nations of Europe, above all Greece, have touched off a more general flight from sovereign debt assets. In simple terms, investors have become intensely fearful that these heavily indebted countries — Greece, Portugal, Spain, Ireland, Italy, even the UK — will not be able to pay back the capital they have borrowed to fund (a) recent bailouts of their financial sectors and (b) their lavish welfare benefits. Multiple rescues of Greece were announced over the course of the spring, with little lasting effect. Finally, about two weeks ago, European leaders unveiled what has been called the Euro-TARP: a package of rescue loans and other devices weighing in at over a trillion dollars.
The European Central Bank was active in this as well. First it announced that it would accept Greek bonds as collateral in its liquidity facilities. That alone was an important step, because these bonds were precisely the securities that were tanking: they were the bonds that very few private actors would accept as collateral. Next the ECB activated a program of “quantitative easing,” meaning that it would openly purchase Greek and other sovereign debt instruments. That momentous measure came out alongside the Euro-TARP.
Even all this intervention, much of it unprecedented, did not really calm capital markets in Europe. There have been rumors, beginning last week, that the ECB and other central banks are intervening in bond markets still further, this time quietly (by what arcane mechanisms I can only guess) — all with an eye toward a gradual and orderly decline in the euro against the dollar and Asian currencies.
Francis Cianfrocca has a good summary of the whole mess here.
The US has been (so far) spared the kind of disruptions Europe experienced, but given the volatility we’ve seen, who can be confident this will last? These disruptions could easily derail our rather anemic and government-driven recovery. A stronger dollar vis-à-vis the euro hurts our exporters; and high-end manufacturing, which are heavily-dependent on exports, is one sector that has shown some real life in recent months.
More ominous still, sovereign debt fears in Europe augur the same over here. The US may not be as heavily indebted a Greece or Spain, nor is our welfare sector quite so generous (we do not yet pay public sector employees lavish retirement benefits in their early fifties, or distribute to them 14 “monthly” paychecks), but we’re not far away. Both the current and the previous administration have been downright profligate, expanding domestic programs and undertaking hugely expensive foreign adventures. We are shielded from the immediate consequences of this profligacy by both the fact that the dollar is still the world’s reserve currency and the fact that dollar-denominated debt assets, still seen as the least risky around, benefit from investors’ flight from risk.
For me the takeaway from all this is two-fold:
(1) The economic environment is still strongly deflationary. Financial assets are losing value. Even the vast flood of new dollars, euros, pounds, yen, etc., has failed to prevent these losses; it has only managed to delay and dilute them.
(2) The crisis in confidence is shifting from private (above all banking) assets to public assets. Having rescued finance capitalism from insolvency in 2008, governments are now feeling the sting themselves. They themselves may not be solvent.
Finally, it will come as no surprise to What’s Wrong with the World readers, but all this disorder only confirms my judgment that globalization has been a ruinous boondoggle. We might say that the European Union is the quintessential institution of globalization. In financial terms it can be seen as the project to allow Greece, Spain, Italy and other countries on the periphery of Europe “borrow” the balance sheets of Germany or France in order to issue debt to fund their entitlement programs. In other words, the weaker nations of Southern Europe could borrow at German rates. There is your integration of capital markets in bald summary. In the US, globalization allowed us to export our consumer demand around the world, and bring in capital in return. This capital went chasing after ever higher yields. If you ever read an article on exotic bond market instruments and wonder how the hell these financiers could get away with constructing these bizarre things — synthetic securities confected out of derivatives attached, off at the end, to a tract of houses in Florida or Arizona sold to unemployed single mothers or college students — you may find your answer in the insatiable hunger for higher yields. Pension plans built on assumed 8% annual returns will not be satisfied with a basic mortgage-back security; they need more risky instruments to reach that sort of yield. Indeed, to my eyes the role of institutional investors — pensions, sovereign wealth funds, endowment funds, etc. — in driving the crisis of finance has been unwisely neglected. But it was only possible for this capital to go racing around the world after yield, mouse-click by mouse-click, because capital markets were growing ever more integrated. This liquidity in bond markets was the authentic and intended consequence of globalization. It had the effect of wildly inflating financial assets around the world. Capital could be lent by some small town in Australia with an investment fund, and almost instantly appear, through intermediaries in London and on Wall Street, for use in the digital coffers of mortgage finance companies in Southern California. What was not intended was the bankruptcy of said Australian town when the California mortgages went sour.
Now all these assets, inflated by the novelty of bond-market liquidity and the illusory stability of global integration, are deflating; and there ain’t much anyone can do about it.