The eurozone crisis will bring more volatile times ahead, but it’s not the end of the world
Tuesday, May 22, 2012/
The good news is that most of the problems we come across have multiple solutions. The question becomes how any solution goes about staunching or eliminating the problem. That is, what actions the solutions involve, and the costs incurred when undertaking them.
By nature and long-time conditioning, I am a fairly solutions-oriented person. I’ve spent much of my life engaged in practical and research-based problem-solving, and complex, protracted, multi-party commercial negotiations involving large amounts of capital.
Through iterative trial and error, I’ve learnt a lot doing so. There is, frankly, no substitute for experience. Practical intelligence is a much experiential as it is innate. You need both. But most know that.
One of my reflex responses to the new “crises”, “catastrophes”, and “end-of-world” scenarios that are canvassed all too often is that there is almost certainly a solution out there in the ether. The solution might be easy, or it might be hard. But there is normally one, if not more than one, answer. It is a matter of methodically going through the rigmarole of identifying what they are, securing the support you need to implement the optimal one, and then vigorously executing it.
Accordingly, I tend not to get too worked up by new problems. I do get anxious thinking about risk, because I can see a lot of prospective risk. But I find it hard buying-into extreme, end-of-days negativity that ignores the answers.
So I regularly scratch my head when I watch the wild gyrations in financial markets oscillating from extreme optimism to pessimism as one new global challenge emerges after another. I frequently see the same swings in the views of the people paid to talk about these markets. One minute the Aussie dollar is going to 120 US cents, the next it should be falling like a stone. Another day the resources boom is a locked-in certainty for years to come with inflationary consequences, the next it is all over, red rover.
Don’t get me wrong: I am believer in changing your mind when hard data comes to hand if it is view-altering. But my sense is that many people echo and amplify the schizophrenia, or multiple personalities, projected by financial markets. A concern is, as George Soros wisely noted, that this “reflexivity” can itself influence real-world outcomes.
I think one reason financial markets tend to “overshoot” so often is because capital at the margin can overweight the observed challenges relative to the expected solutions. This is probably tied to our so-called “asymmetric value functions”, for which psychologist Daniel Kahneman was awarded the Nobel Prize in Economics. His work showed us that when making decisions, people seem to weight expected losses more than gains. One might extend this framework to perceived problems (losses) and their remedies (gains).
In obsessing over problems, I’d argue people neglect the next logical link in the chain: the public-political “reaction function”. That is, our response. By its construction, any democracy is highly geared to searching out solutions to imminent threats (the wrinkle, of course, being that many supposed threats are, in fact, non-threats). The risk is that democracies focus too much on short-term, as opposed to long-term, salves. Nonetheless, this maniacal focus on eliminating problems that are perceived to afflict the majority of people may be a dynamic key to the longevity of democracy as an organising model for societies.
For years I’ve argued that we should expect higher volatility in financial markets because of the profound impact the Internet and globalisation are having on investor decision-making. There is a connection to this and Soros’s theory of reflexivity, which I have highlighted before. In particular, I believe we are seeing much more reflexivity between the opinions of participants, security prices, and real economies as a function of the Internet. I’d also argue that policymakers sometimes get trapped into compounding this reflexivity. This is why I’ve encouraged the RBA not to over-engineer monetary policy. The RBA should think slowly: it meets monthly and the passage of time is its friend insofar as it yields more information.
I do wonder how well equipped humanity is to deal with the tight linkages we’ve created between individual economies via the digitalisation of information and its real-time transmission through the internet. Speaking to a senior commentator last week, I said, “It’s like the world has contracted a case of attention deficit disorder. Too much low-quality, uncensored information influencing actions too much of the time. Our brains were not built for rationally and instantaneously processing the quantum of data we are given nowadays. We need more time to evolve.”
Right now, I think we need to slow down, dispassionately contemplate our conditions, and work out the best roads to take. Humanity is not facing an existential threat. Life will continue much as it has done in the past. The great thing about the future is that it builds on thousands of years of human progress. Given this, and the commitment of many to further “innovation”, it is likely that our quality of life will continue to improve, albeit on a scale of decades rather than days.
This brings me to what must now be described as the third chapter in the great European sovereign debt crisis. The only thing I am confident about is that nobody really knows what will happen because there are simply too many complicated and interwoven future paths for the eurozone. I personally find it hard to wrap my mind around. I would be sceptical of anyone expressing a strong opinion on what will occur. A few observations I think are, however, worth reflecting on.
First, according to reports, 80% of Greeks actually want to remain part of the currency union. This is important: the democratic impetus will be geared towards a non-disruptive compromise.
Second, an orderly (as opposed to disorderly) Greek exit from the eurozone would likely be disastrous for the currency union and significantly increase the probability of other nations leaving. If you think this through, the likes of the ECB, EC, Germany and France have every incentive to: (1) reach a sustainable solution that allows fiscal transfers/subsidies between nations in order to assist the adjustment process for indebted countries; and (2) in the event Greece does decide to exit, make the costs of departure seem extremely high for the Greeks so as to try and salvage the perceived value of remaining in the eurozone.
Third, if you assume that you can overcome the intrinsic problems of consensus-based decision-making (a nightmare I have regularly broached here) in the EU, there appear to be practical solutions to a lot of the problems individual nations face. These include the development of a shadow Greek Euro currency, which Deutsche Bank’s Torsten Slok calls the “Geuro”, Eurobonds and/or eurozone-backed “project bonds” (likely to be announced on Wednesday), an EU-wide bank deposit guarantee, nations agreeing to cede partial authority over fiscal policy, or pay penalties, if they default on commitments, and others smart people have proposed. On the notion of a “Geuro”, Deutsche’s Slok argues:
Greece is unlikely to formally leave the euro, nor are the other euro area countries likely to abandon Greece entirely. The path of least resistance could be the stop of financial assistance to the Greek government and the continuation of payments for debt service and the stabilization of the Greek banks in a European “Bad Bank”. In this case, a Greek parallel currency to the euro (which we dub the “Geuro”) could emerge when the government issues IoUs to meet current payment obligations. This would also allow Greece to engineer an exchange rate devaluation without formally exiting EMU.
My parting thought is that the political will to implement solutions will not galvanise until individual societies fully grasp the costs of a eurozone break up. So prepare yourself for more abseiling. Life is unlikely to get any less volatile.
Christopher Joye is a leading financial economist and a director of Yellow Brick Road Funds Management and Rismark. The author may have an economic interest in any of the items discussed in this article. These are the author’s personal views and do not represent the opinions of any other individual or institution. This material is not intended to provide, and should not be relied upon for, investment advice or recommendations.
This article first appeared on Property Observer.