Thursday, November 10, 2011

Italy and Miss Market

I call her miss market because she throws tantrums. The sad part is that she has been taught to throw tantrums and expects instant gratification. She is an impossible 6 years old.

Of course the official version is that she is called "Mr market", carries a big manly stick and that he has the wisdom of crowds. Theory of numbers says that truth will be found in the market vote, because it represents the opinions of the multitude where all information resides.

That is the theory. The practice is that in this media driven, internet delivered news world, hysteria and market sentiment fluctuate on a weekly basis. We have gone from despair to euphoria to despair again, in less that 10 days.

Ganging up

There has been various report of the infamous NYC hedge fund get together. This is where "money" gets together in a smoked filled room, sipping on whiskey and decides which target to pick on next. Apparently last year they decided Greece and the Eurozone. There is no end to greed. Of course reality is probably more prosaic, with boring lunches being planned and people just following the internet news cycle. No need for mafia style 1920 get togethers.

Choose your target
The FT of late likes to talk about "flaws' in the eurozone, mostly pointing out that people are different and that couldn't work. The reality is that it is BY DESIGN, that is the whole point, to bring together people that were slaughtering each other 70 years ago so, yeah, it is bound to be bumpy. The major flaw, imho, is not the disparate composition, but rather the fact that the bond mechanisms were open to snipers, essentially countries can fall one by one. First it was Greece (with reason probably) now it is italy. The problem in italy does not warrant the panic going on but no matter, the only thing that matters IS THE PANIC ITSELF. Hedge funds CAN create a panic by aligning.

Choose your weapon
The weapon of choice is the naked CDS, the hedge funds will run the cost of funding up by piling on on the buying side of the CDS. In parallel they are probably buying the cheap debt that less nimble actors are dumping and sit on it until the central banks intervene with liquidity. Central banks like the ECB cannot print money. This induces a negative spiral: higher cost of funding for sovereigns, means lower spending, means more recession, means less income, means higher cost of funding. The boat is capsizing with Italy above 7%. As soon as your cost of funding is more than your growth, you have a negative cash flow problem that can only get worse by this spiral.

Hold everyone hostage
The problem with Naked CDS is that it takes the nominal problem (the size of the debt) and multiplies by 10. So your little greek problem that was 300B is suddenly 3T. Size matters. A 3T transfer in cash WILL DESTABILIZE ANY MARKET. That was the reason for the Geithner trip to EU. That is the reason the ECB was a voluntary haircut. The size of the italian debt is supposedly 1.5T. So now we have a 10T hole? It makes NO SENSE. These are clearly weapons of mass destruction whose ONLY reason d'etre is speculation. BAN CDS.

QE is the pacifier
The reaction by the central banks in the US and UK: to print money. To print money in the face of deflation is not inflation as a result, just an inflationary contribution in the a deflationary background for a STILL deflationary (albeit less) result. Those who do not understand that point mistake stock and flow. We are talking about flows here. So QE is the way to stabilize the markets. The ECB cannot do that by constitution and the germans view this experience through their own historical Weimar lens. When free money is injected, the markets stabilize, the stocks rally etc etc.

Miss market throws a tantrum
So the italian government is toppled, the greeks are about to be thrown to the wolves of depression (how long it last depends on whether they stay or not in the euro, but default they will). Miss Market is having her way, everyone still deifies her and wants to appease her. She wants QE and QE she will get.

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