Wednesday, August 8, 2012

Capital Strike

I used to think that the notion of a "capital strike" was a right wing fantasy, grist for Ayn Rand novels but not to be taken seriously. Lately, I'm not so sure. Since 2009, instead of buying risky assets (stocks, for instance), which would help grow the U.S. economy, large institutional investors like pension funds and endowments have taken their ball and gone home. Or to be precise, locked it up in US government bonds which, unlike stocks, do not directly boost economic growth. You would have expected risk-averse investment behavior in the immediate aftermath of the Great Recession; in 2008, with demand weak and growth prospects low, the stock market was a particularly inhospitable climate. But it's gone on too long; today, three years later, investors are still buying up government bonds in droves; and in the meantime these bonds have become extremely unattractive investments. The key thing to know about bond buying is that you accept a relatively low return on your investment (yield) in exchange for the virtual guarantee that you will get your money back at the end of term (maturity). But in part because the federal reserve has driven its short term rate down to just above zero (to spur investment by reducing the cost of financing), the yield on 10 year U.S. treasuries is currently 1.68%. Assuming annual inflation of roughly 2%, buying a U.S. T-bill is now simply a guaranteed way to lose money.

And yet they keep buying them. Perhaps all of this so-called "risk off" behavior has less to do with rational pessimism about growth prospects than with simple petulance. Here is the context: free market fundamentalists have just seen the incineration of a key pillar of their worldview. The myth of the "bond vigilante" is busted: despite obscene debt ratios, U.S. and UK government debt pays negative real yields. At the same time, central banks are undertaking large scale intervention in the markets in an attempt to boost stock prices and discourage bond buying. The investors I talk to whine constantly about this, which they call "market distortion" and "financial repression". They make me think of a child's temper when a favorite toy is taken away.

For an example of an investor tantrum, read this Financial Times op-ed from Bill Gross, head of the world's largest bond fund, PIMCO:

Psst! Investors – do you wanna know a secret? Do you wanna know what Angela Merkel, Fran├žois Hollande, Christine Lagarde and Mario Draghi all share in common? They want your money!
They’ve wanted it for years now but you are resisting by holding on to it or investing it at negative interest rates in Switzerland, Germany and a growing number of other countries considered to be European Union havens. They want you to be less frugal and more risk-seeking. They want your money as a substitute for theirs in Spain, Italy and, of course, Greece, but they don’t mention that any more. The example would be too off-putting. “Investors,” they plead, “show us your money!”

It's hard to imagine anything Gross could have written that would have more thoroughly validated the charge of financier petulance.

1 comment:

  1. "The political involvement is so extreme — we have not seen this since the postwar era. What they are doing is trying to thwart natural market outcomes."

    --"hedge fund titan Louis M. Bacon" in the NYT.

    The notion of a "natural market outcome" would be a really funny joke (I am picturing Midtown Manhattan blanketed in undergrowth, orchids flowering from water towers, three-toed sloths clinging to the empire state building), except that financial participants really believe something like this: that our ultra mathematical, high-tech financial markets are natural and organic and deserve special protection, like rare rhinos menaced by poachers in the Kenyan savannah.

    This conception of markets is completely wrong, and the accompanying lack of concern for the ordinary people who suffer as a result of financial crises is morally obscene. Bacon and his kin are Mellonists (see below). For them the economy is like a human body, and a financial crisis is like a vigorous workout. Pain is just a necessary, even beneficial, stage in the process of becoming more fit… as long as it is other peoples’ pain.

    (In 1931, Treasury Secretary Andrew Mellon advised Hoover to "liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate... it will purge the rottenness out of the system." Said liquidation would be accomplished by withholding aid to distressed businessmen, laborers, banks, etc. We know how that turned out.)