Analysis: The trust of a rogue

LONDON Wed Sep 5, 2012 1:51am EDT

LONDON (Reuters) - Seek the trust of financial markets, but only so far as you can trust them.

Germany's paradoxical stance towards financial markets - lauding them for imposing economic discipline, lambasting them for short-termism and irrationality - has been advanced again in series of recent speeches.

Perhaps preparing the public for a renewed effort to realign skewed euro debt yields - as the European Central Bank is expected to outline this week - or maybe just underlining the need for more financial regulation and supervision, Germany's Chancellor Angela Merkel was scathing about markets this week.

She insisted Germany's "guiding principle" remained that of a social market economy, where markets are not allowed to "run wild" and must serve the people rather than the other way around.

"When we look at international markets over the last five years, then we see that they haven't served people, rather they enriched a few, and many people around the world have paid the price for this," she told Bavarian festival goers on Monday.

"The main task for politics today is to bring the spirit of the social market economy into the financial markets so that international financial crises don't repeatedly ruin what people have built up with their own hands and hard work."

Noble sentiments for sure and hardly controversial. Five years of seemingly endless credit turmoil, bank collapses and market herding have hobbled the world economy and clearly expose the folly of free market excesses.

But the puzzling bit of the German message is that its skepticism about market efficiency comes in tandem with an insistence that other euro zone countries - and presumably businesses and households - should secure the confidence of those same markets it so deeply mistrusts.

In an interview with the Irish Times newspaper last month, for example, German Finance Minister Wolfgang Schaeuble stressed repeatedly that bail-out countries such as Ireland or Greece needed to stick with austerity and reforms to rebuild the trust of markets rather than seeking more concessions from euro partners.

Yet, in the same breath, he implied that investors and creditors in the United States or Asia probably didn't understand the nuances of reasonable policymaking.

"We cannot do anything that generates new uncertainty on the financial markets and lose trust which Ireland is just at the point of winning back," he said, referring to Irish requests for direct European support for its banks - such as Spain received - that would reduce the heavy debt burden on the government.

"We will have to avoid generating a headline like 'Aid program for Ireland topped up' because then investors in California or Shanghai might not understand that this top-up is a reward for Ireland."


Now, doubting the sophistication or foresight of investors is consistent at least with Germany's long-held market skepticism.

But the parallel insistence that these random players should be viewed as arbiters of good policy then seems odd.

"The Germans have had this long, weird interplay with the markets - they don't like to be led by them, but at the same time my suspicion is they often try to use the markets to execute goals they want. I think that's behind this complex situation still unveiling in Europe," said Jim O'Neill, chairman of Goldman Sachs Asset Management.

"They don't want to be dictated to, but they sure like using the markets to push other countries in directions the Germans want to go," he told Reuters Insider television.

So is the German position toward free markets, their regulation and the need for routine government or central bank intervention just Machiavellian or does it have its own logic?

Bernhard Speyer, joint head of Deutsche Bank Research, reckons the stance is highly reflective of German public opinion - that finance and free markets are useful only up to a point and are there solely to serve industry rather than being wealth-generating industries in their own right.

"There are two views at work. First is that financial markets do not understand the constraints of policy or respect the primacy of democratic developments and governments must therefore enforce the latter.

"The second is financial markets by themselves are not able to find a stable equilibrium and that's another justification for constant government intervention, albeit one with a consequence of making markets even more volatile."

Speyer reckons this idea of using market forces to some extent, but in tandem with government direction or intervention, has been around since the euro was first devised. The monetary union treaty has both a "no-bailout" clause and a government administered "stability and growth" pact.

This dual thread persists today. Germany demands reform and cuts to gain market trust while developing an intergovernmental fiscal pact and agreeing intervention by the ECB or European Stability Mechanism to correct market skews.

"I think there's a grain of truth on both sides and if you take that as a foundation for the 'muddle through' approach of European institutions in this crisis, then it all starts to appear more strategic than at first sight."

(Additional reporting by Alexandra Hudson and Axel Threlfall; Editing by Ruth Pitchford)

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Comments (2)
reality-again wrote:
Interesting article that touches a basic flaw in the way we think about political leaders in ‘serious’ western democracies.
We naturally assume that since these people are democratically elected, and subject to intense scrutiny and criticism, they would tend to adopt the most rational views and act in the most effective way.
Sadly, it’s not what happens in reality, as we all know from our own experience with such people, what they believe in, and what results they achieve in the long run.
It’s all about the difference between rationalizing and being rational, and between being successful with one’s voters and being successful in the real world.

Sep 05, 2012 8:50am EDT  --  Report as abuse
dareconomics wrote:
Successful politics revolves around two tasks. The successful politician must take the credit for positive developments and shift the blame for negative events. Germany is no different from any other country in this regard.

This quote embodies what Merkel is trying to achieve:

The main task for politics today is to bring the spirit of the social market economy into the financial markets so that international financial crises don’t repeatedly ruin what people have built up with their own hands and hard work.

Bringing the spirit of the social market economy into the financial markets means attempting the control these markets through central planning. This precisely what is occurring today through the central bank control of the money supply.

What people do not understand is that this very control is what makes the markets volatile and prone to crises in the first place. For example, the Federal Reserve has kept interest rates at near zero for about four years. This action has raised the price of all debt in existence creating today’s bond bubble and other market distortions including commodity price inflation.

Government intervention is what causes these problems, not free markets. When there is a market crash, we should allow it to play out. Eventually, the market will clear, and asset prices will stabilize. By intervening, the government merely prolongs the agony.

If you ever believe that journalists are neutral, read this passage referring to Merkel’s statements:

Noble sentiments for sure and hardly controversial. Five years of seemingly endless credit turmoil, bank collapses and market herding have hobbled the world economy and clearly expose the folly of free market excesses.

The author is aware of the problems of the GFC, but attributes them to free market excesses. Clearly, the author believes in government intervention. The issue here is that the free markets are not what caused the GFC; it was years of low interest rates from the Greenspan-led Fed that caused a succession of bubbles. Just like ancient bloodletting, the cure is really the disease.

Germans do distrust free markets. Look at their history. To a German, the free markets imposed on the country following WWI helped cause the hyperinflation that led to the rise of Hitler; however, it was the Reichsbank that printed money in virtually unlimited quantities that caused the hyperinflation. The Reichsbank was part of the government. It was intervening in order to keep the government afloat, because it would not make the budget cuts necessary to remain solvent.

The market is the democracy of money. Investors vote their dollars, euros, or quatloos by purchasing and selling securities. Every bit of power that a citizen holds by virtue of the vote and the freedom to spend his money on whatever he wishes is jealously desired by the politician. By attempting to control these money votes, the politician is attempting to increase his own power at the expense of the people.

Spain, Italy and Greece could drastically cut their budgets, but then the politicians would be ceding control of that money and unable to spread it around to ensure their reelection. So they try to hold on to this power by attempting to control the market instead. What they are doing is dictating a price for their government debt that will allow them to continue doling out favors to remain in power.

Government intervention is oppression, and the people will support this oppression as long as they get their cut. It is dawning on Europeans that they are getting shafted. They continue to pay high taxes but are slowly but surely losing the benefits to which they are entitled for these tax payments. The realization that the social contract has been broken will result in countries refusing to pay their debts. The political will to keep the status quo going will evaportate when the people realize that they have been cut out of the bargain.

Sep 05, 2012 1:23pm EDT  --  Report as abuse
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