Speculative thoughts – round 2

It appears that developments have moved on quite dramatically since my last blog on the market describing the political dynamics between governments and capitalist investors (insert speculators here!). There are a number of key points in the latest round of sparring that I think should be highlighted.

Firstly, European governments have taken the kind of action speculators respect and can’t ignore. European authorities shocked markets last week by announcing a huge €750bn bailout fund for the eurozone . Additionally, the European Central Bank said that it was ready to purchase eurozone government and private debt to ensure depth and liquidity in markets. The ECB has noted that it will sterilise the bond purchases, meaning that it will not quantitatively expand the money supply like in the UK. After an initial bout of investor exuberance the enthusiasm of market participants has waned since the announcement. It has dawned on everyone that Europe still faces significant hurdles and there are growing fears that the situation could send the global economy back into recession.

Secondly, as Stefan wrote yesterday, the German authorities have decided to attack market disorder and valuations by banning naked short selling of European government bonds, credit default swaps, and some German financial securities. This is the type of action that speculators can not ignore, and will not respect. The move by the German authorities has caused confusion and uncertainty in markets. France was quick to say that it will not follow suit and said these measures could actually hamper market liquidity. The move raises more questions than answers. For example, how will it be applied? Who does it apply to? Which jurisdiction does it apply to? How will it be monitored? How will investors be prosecuted and fined if found guilty of short selling? I am sure you can think of even more.

These are serious questions for market participants. Unfortunately, markets do not close while we await the answers of the above. The effect will be to increase uncertainty, make markets less efficient, and could therefore possibly increase risk premiums. One would think that these results are the opposite of what the authorities are trying to achieve.

As I write, trying to understand the above new set of rules is vexing many market participants. I think the issue will be that if governments start to try to fix the price of markets at a set level through political and legal policy, the invisible hand of the markets could well be inefficiently bound. Increasing regulation in Europe will see investors increasingly look at other markets to invest in. I hope the European governments realise that they are still going to need to borrow in the coming months and years, and to do that they will need a big, deep, and liquid market.