My colleagues know me to be quite pessimistic about the future, grumbling remarks like, “It’s always darkest just before it goes pitch black.” But I am not alone. Pessimism regarding the future is a quirk of our trade.
Being pessimistic provides the advantage of compensating the well known “optimism bias” in behavioral finance, the systematic tendency for individuals to overestimate positive future outcomes and underestimate negative ones. It can also be seen as an effective strategy in forecasting. You are forgiven much more easily for being wrong about a negative forecast than about a positive one. In the first case, the public will happily forget the bearish forecast, while in the second case it will blame the rosy forecaster for not having seen the darkness coming.
So I’m a joyful pessimist. Nevertheless, two weeks ago I met my match when debating with the chief investment officer of a successful London hedge fund. A smart and eloquent gentleman, his view of the future was even bleaker than mine: “The US hasn’t even started its deleveraging process. So far, the enormous debt has only been shifted from one entity to the next. It will take at least 15 years of quasi-stagnation to bring the US back on track. The euro will implode. China is facing the mother of all housing bubbles,” and so on…
When asked what made him the most skeptical about his own forecasts, he had this answer: “I am a contrarian, taking more often than not the opposite view of the market consensus. It has been one of the foundations of my investment success. However, currently – quite unusually, I must say – the consensus is also very pessimistic, which makes me uncomfortable.”
In fact, being pessimistic and being a contrarian come in tandem. Since the crowd normally falls for the optimism bias, pessimism is a corollary of being contrarian. Logically, this means that a pessimistic herd would produce a sense of cognitive dissonance for a contrarian – someone who takes the opposite view of the consensus. How can this be solved?
Psychology will tell you that when confronted with cognitive dissonance, you need to reduce one of the sources of it. So in our case, either you follow the pessimistic herd, or you become an optimistic contrarian.Or, you can always seek another strategy to mitigate the paradoxical information. This is what my interlocutor actually did: “In fact, while the consensus of analysts is pessimistic, the crowd of investors is not, just look at the market since the beginning of the year.” We’ll see how this plays out…
Friday, January 27, 2012
Friday, January 20, 2012
20/12/2012: The French dramAAA
Markets expected it, Standard & Poor’s signaled it two months ago. Even French government officials showed resignation recently. Nevertheless, the news of the downgrade of France’s credit rating from AAA to AA+ fell just short of a national tragedy.
Just after the decision last weekend, French media suggested that the nation had not been so humiliated since “Les Bleus” were ousted in the first round of the 2010 World Cup.
It occurred only 100 days before the presidential elections. All candidates (with the notable exception of the French President himself), have commented on the downgrade, and are blaming the government and its fiscal policy of the last five years for the loss of the AAA.
Even worse, mere months ago, after the downgrade of the US, Mr. Sarkozy insisted that France would not lose this “national treasure” under his watch. In retrospect, this was a tactical mistake for the prospects of his reelection. The vast majority of the French population didn’t know what a AAA rating meant before it was so prominently put forth by their president. Now, though, the downgrade has hurt the national pride.
Unfortunately for Mr. Sarkozy and his government, this downgrade came while Germany not only stays at AAA, but has an outlook that remains stable. So the downgrade cannot be framed as a European problem, but must be considered French-specific.
None of this bodes well for Mr. Sarkozy, who currently lags in the polls. Unclear, though, is whether his main competitor, the Socialist François Hollande, will really profit from this. Initial reactions in the media indicated that both the centrist François Bayrou as well as Marine Le Pen from the far right could be the main beneficiaries among candidates.
This could seriously jeopardize Mr. Sarkozy’s chances to reach the second round of the election. The latest polls published before the downgrade showed Mrs Le Pen just behind Mr. Sarkozy in terms of vote intentions in the first round.
Therefore, a worst-case scenario, like that of 2002, when the far right candidate Jean-Marie Le Pen, the father of Mrs Le Pen, entered the second round, cannot be excluded anymore. This may prompt Mr. Sarkozy to adopt a far more populist tone in his Presidential campaign. Initiatives like the unilateral introduction of a tax on financial transactions already point this way.
Unfortunately, the French downgrade is not only a French bane. It also affects the European debt crisis. The downgrade of France resulted a couple of days later in the downgrade of the European Financial Stability Facility. This will impact its funding costs, making rescue plans more expensive and more complex.
It also puts a wedge between the German-French leadership of the crisis. So far, despite the spread widening observed between German and French interest rates since the beginning of the European debt crisis, their leaders discussed on the same eye level. The downgrade demoted France clearly to junior partner, or even lower, in the tandem.In the French Le Parisien a couple of weeks ago, Mr. Sarkozy expressed the wish not to become “the leader of the Club Med.” Criticized across the political spectrum and held personally responsible for the downgrade by many French, the undeclared candidate might well change his tactics in the coming weeks, opting for a more confrontational course rather than shadowing Germany. In this respect, the next European summit on 30 January will be very important.
Just after the decision last weekend, French media suggested that the nation had not been so humiliated since “Les Bleus” were ousted in the first round of the 2010 World Cup.
It occurred only 100 days before the presidential elections. All candidates (with the notable exception of the French President himself), have commented on the downgrade, and are blaming the government and its fiscal policy of the last five years for the loss of the AAA.
Even worse, mere months ago, after the downgrade of the US, Mr. Sarkozy insisted that France would not lose this “national treasure” under his watch. In retrospect, this was a tactical mistake for the prospects of his reelection. The vast majority of the French population didn’t know what a AAA rating meant before it was so prominently put forth by their president. Now, though, the downgrade has hurt the national pride.
Unfortunately for Mr. Sarkozy and his government, this downgrade came while Germany not only stays at AAA, but has an outlook that remains stable. So the downgrade cannot be framed as a European problem, but must be considered French-specific.
None of this bodes well for Mr. Sarkozy, who currently lags in the polls. Unclear, though, is whether his main competitor, the Socialist François Hollande, will really profit from this. Initial reactions in the media indicated that both the centrist François Bayrou as well as Marine Le Pen from the far right could be the main beneficiaries among candidates.
This could seriously jeopardize Mr. Sarkozy’s chances to reach the second round of the election. The latest polls published before the downgrade showed Mrs Le Pen just behind Mr. Sarkozy in terms of vote intentions in the first round.
Therefore, a worst-case scenario, like that of 2002, when the far right candidate Jean-Marie Le Pen, the father of Mrs Le Pen, entered the second round, cannot be excluded anymore. This may prompt Mr. Sarkozy to adopt a far more populist tone in his Presidential campaign. Initiatives like the unilateral introduction of a tax on financial transactions already point this way.
Unfortunately, the French downgrade is not only a French bane. It also affects the European debt crisis. The downgrade of France resulted a couple of days later in the downgrade of the European Financial Stability Facility. This will impact its funding costs, making rescue plans more expensive and more complex.
It also puts a wedge between the German-French leadership of the crisis. So far, despite the spread widening observed between German and French interest rates since the beginning of the European debt crisis, their leaders discussed on the same eye level. The downgrade demoted France clearly to junior partner, or even lower, in the tandem.In the French Le Parisien a couple of weeks ago, Mr. Sarkozy expressed the wish not to become “the leader of the Club Med.” Criticized across the political spectrum and held personally responsible for the downgrade by many French, the undeclared candidate might well change his tactics in the coming weeks, opting for a more confrontational course rather than shadowing Germany. In this respect, the next European summit on 30 January will be very important.
Saturday, January 14, 2012
14/01/2012: Nowhere to hide from governments in need
When governments need money, they shake down the citizenry. The cudgel of legality may justify measures that are borderline ethical and can amount to slow, torturous bleeding of cash or asset value into state coffers. Present poor finances in many nations signal we may be in for repeated summons to pay.
During a presentation in Hamburg two years ago, I insisted that ultimately the enormous creation of money and the monetization of government debt, we’d been seeing in the US, the UK and also – although indirectly – in Europe, would lead to massive inflation. From this I segued to hyperinflation. Asked in the plenum how to protect against such a scenario, I gave the obvious answers: gold, real estate and everything related to “physical” assets.
Afterwards an older gentleman approached me: “I disagree with you on your last statement regarding good investments in circumstances of hyperinflation. My grandparents mastered the German hyperinflation of the early 1920s well, because they had prime real estate here in Hamburg and also in Berlin. However, once the hyperinflation was over, the German government was still in need of money. So it put prohibitive, even confiscatory, taxes on real estate, and my grandparents lost half their wealth.”
This made me ponder the issue more deeply. The difficulties of developed economies currently are not due to ultra-expansive monetary policies, which could lead to inflation. Governments have a much more profound problem (to which inflation is one solution): the lack of funding of their expenditures going forward. In simple terms: Governments need money and will do whatever they can to find it.
No asset is safe when a government needs money. When President Franklin Roosevelt decided to debase the gold value of the US dollar from one twentieth of an ounce to one thirty-fifth of an ounce (a devaluation of 43%) in 1933, he issued Executive Order 6102 and forbade the hoarding of gold in the US. During the Argentinean crisis in 2001, when the government started to devalue the peso, it introduced the so called “corralito,” freezing all domestic bank accounts (both in pesos and US dollars), and then the “corralón,” forcibly exchanging the deposits (including the US dollar ones) in peso-denominated bonds.
Last year Hungary – in financial need – decided that private pension funds would be de facto nationalized and would help to finance the government debt. France is presently considering introducing a so-called Tobin tax on financial transactions, if needed. This tax, labeled an “absurdity” in 1999 by French President Sarkozy, is in my view more than just a gimmick to woo French voters, punish mean financial markets and to annoy the British. With a debt-to-GDP ratio which will hit 90% this year, a deficit that refuses to decline, and very bleak growth perspectives, France is in desperate need of fresh sources of financing.I think that in the next couple of months and years, with growth remaining subdued due to demographic constraints and with unfunded public liabilities becoming more perceptible, the risk that governments will adopt Procrustean measures to cut their funding needs to size will dramatically increase. Hence we could see more financial repression, capital controls, tariffs and trade barriers and ultimately the decline of globalization.
During a presentation in Hamburg two years ago, I insisted that ultimately the enormous creation of money and the monetization of government debt, we’d been seeing in the US, the UK and also – although indirectly – in Europe, would lead to massive inflation. From this I segued to hyperinflation. Asked in the plenum how to protect against such a scenario, I gave the obvious answers: gold, real estate and everything related to “physical” assets.
Afterwards an older gentleman approached me: “I disagree with you on your last statement regarding good investments in circumstances of hyperinflation. My grandparents mastered the German hyperinflation of the early 1920s well, because they had prime real estate here in Hamburg and also in Berlin. However, once the hyperinflation was over, the German government was still in need of money. So it put prohibitive, even confiscatory, taxes on real estate, and my grandparents lost half their wealth.”
This made me ponder the issue more deeply. The difficulties of developed economies currently are not due to ultra-expansive monetary policies, which could lead to inflation. Governments have a much more profound problem (to which inflation is one solution): the lack of funding of their expenditures going forward. In simple terms: Governments need money and will do whatever they can to find it.
No asset is safe when a government needs money. When President Franklin Roosevelt decided to debase the gold value of the US dollar from one twentieth of an ounce to one thirty-fifth of an ounce (a devaluation of 43%) in 1933, he issued Executive Order 6102 and forbade the hoarding of gold in the US. During the Argentinean crisis in 2001, when the government started to devalue the peso, it introduced the so called “corralito,” freezing all domestic bank accounts (both in pesos and US dollars), and then the “corralón,” forcibly exchanging the deposits (including the US dollar ones) in peso-denominated bonds.
Last year Hungary – in financial need – decided that private pension funds would be de facto nationalized and would help to finance the government debt. France is presently considering introducing a so-called Tobin tax on financial transactions, if needed. This tax, labeled an “absurdity” in 1999 by French President Sarkozy, is in my view more than just a gimmick to woo French voters, punish mean financial markets and to annoy the British. With a debt-to-GDP ratio which will hit 90% this year, a deficit that refuses to decline, and very bleak growth perspectives, France is in desperate need of fresh sources of financing.I think that in the next couple of months and years, with growth remaining subdued due to demographic constraints and with unfunded public liabilities becoming more perceptible, the risk that governments will adopt Procrustean measures to cut their funding needs to size will dramatically increase. Hence we could see more financial repression, capital controls, tariffs and trade barriers and ultimately the decline of globalization.
Friday, January 6, 2012
06/01/2012: The sun is setting on the dollar's empire
The foreign exchange world just got more complicated. Two small pieces of news over the holidays suggest that the preeminence of western currencies – especially the US dollar – is on the wane, even if they continue to grab most of the media limelight.
If these first few days have been anything to go by, the US and Europe will once again dominate the news in 2012. French President Sarkozy and German Chancellor Merkel will soon meet to prepare for the European summit later this month – which at least has not been defined as another “last-chance summit” (not yet, anyway). In the US, the Republican Iowa caucuses officially launched the presidential campaign that will be with us for the next several months. We think investors will still see the US dollar as a safe haven despite the election uncertainty, which should keep it strong against the euro.
So, same old, same old? Not so fast. Two stories indicate that the US dollar is nevertheless losing more ground as the world’s reserve currency. Chinese Premier Wen Jiabao and Japanese Prime Minister Yoshihiko Noda announced over Christmas that they will promote the use of their own currencies in bilateral trade, rather than passing these transactions through the US dollar.
This in itself is nothing new: China already has similar agreements with several trading partners, most notably Brazil. But the volume of bilateral trade between China and Japan – the world’s second and third largest economies – is five times bigger than that between China and Brazil. China is Japan’s main export destination, and Japan is number three for China, behind the European Union and the US.
At the same summit, Japan announced that it would buy around 500 million US dollars initially in Chinese government bonds – but these bonds will be denominated in yuan. The amount itself may be small, but this deal will clearly help to weaken one of the main objections against the yuan becoming a world-leading currency: the Chinese financial market’s lack of depth. In fact, this could mark the beginning of a virtuous circle. The more assets are issued in the Chinese currency, the deeper the financial market will become, and hence the more attractive it will be to issue more assets in yuan.
Certain Federal Reserve statistics released at the end of December also suggest the dollar might be headed for trouble: Holdings of US Treasuries by foreign central banks had fallen by a record amount of 69 billion US dollars over the last four weeks on record. And if the Bank of Japan hadn’t bought Treasuries as a way of weakening the yen against the dollar, the picture would have looked even worse. The sobering fact is that if Japan and China keep working together on their bilateral exchange rate, this sort of dollar-supporting intervention can no longer be taken for granted.
China and Japan hold so much US public debt that this trend could even impact US interest rates at some stage. Taken together, Asia’s two economic powers – the top two foreign holders of US Treasuries – own a whopping 2.1 trillion dollars of US debt. This constitutes roughly 15 percent of the total US debt, and twice as much as the Federal Reserve’s holdings.If economically powerful countries like China and Japan intensify their efforts to eliminate the US dollar as middleman, it could seriously undermine the dominance of the dollar as the world’s reserve currency. If other countries were to follow suit and reduce their dependence on the US currency, we could see the shine come off of it – and its tarnished self-proclaimed challenger, the euro – once and for all.
If these first few days have been anything to go by, the US and Europe will once again dominate the news in 2012. French President Sarkozy and German Chancellor Merkel will soon meet to prepare for the European summit later this month – which at least has not been defined as another “last-chance summit” (not yet, anyway). In the US, the Republican Iowa caucuses officially launched the presidential campaign that will be with us for the next several months. We think investors will still see the US dollar as a safe haven despite the election uncertainty, which should keep it strong against the euro.
So, same old, same old? Not so fast. Two stories indicate that the US dollar is nevertheless losing more ground as the world’s reserve currency. Chinese Premier Wen Jiabao and Japanese Prime Minister Yoshihiko Noda announced over Christmas that they will promote the use of their own currencies in bilateral trade, rather than passing these transactions through the US dollar.
This in itself is nothing new: China already has similar agreements with several trading partners, most notably Brazil. But the volume of bilateral trade between China and Japan – the world’s second and third largest economies – is five times bigger than that between China and Brazil. China is Japan’s main export destination, and Japan is number three for China, behind the European Union and the US.
At the same summit, Japan announced that it would buy around 500 million US dollars initially in Chinese government bonds – but these bonds will be denominated in yuan. The amount itself may be small, but this deal will clearly help to weaken one of the main objections against the yuan becoming a world-leading currency: the Chinese financial market’s lack of depth. In fact, this could mark the beginning of a virtuous circle. The more assets are issued in the Chinese currency, the deeper the financial market will become, and hence the more attractive it will be to issue more assets in yuan.
Certain Federal Reserve statistics released at the end of December also suggest the dollar might be headed for trouble: Holdings of US Treasuries by foreign central banks had fallen by a record amount of 69 billion US dollars over the last four weeks on record. And if the Bank of Japan hadn’t bought Treasuries as a way of weakening the yen against the dollar, the picture would have looked even worse. The sobering fact is that if Japan and China keep working together on their bilateral exchange rate, this sort of dollar-supporting intervention can no longer be taken for granted.
China and Japan hold so much US public debt that this trend could even impact US interest rates at some stage. Taken together, Asia’s two economic powers – the top two foreign holders of US Treasuries – own a whopping 2.1 trillion dollars of US debt. This constitutes roughly 15 percent of the total US debt, and twice as much as the Federal Reserve’s holdings.If economically powerful countries like China and Japan intensify their efforts to eliminate the US dollar as middleman, it could seriously undermine the dominance of the dollar as the world’s reserve currency. If other countries were to follow suit and reduce their dependence on the US currency, we could see the shine come off of it – and its tarnished self-proclaimed challenger, the euro – once and for all.
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