Sunday, May 6, 2012

The politicians' fear of "the markets": the real tail wagging the dog

We all know that finance and the stock markets guide so much of what governments, especially in The West, do. But it's worth reminding ourselves what the purpose of the stock market is.

Companies float create shares (float on the stock exchange) in order to increase the revenues of the share-holders, and therefore the company. But what causes the price of shares to go up or down is "events", and confidence in the future. Buying and selling shares is, as is well-known, a glorified form of gambling. If you've ever looked the frenetic behaviour of stock-brokers in the FTSE or anywhere else, and their knee-jerk reaction to bad news, you'll quickly get the (correct) assumption that stock markets are the arenas of capitalism. And it is far from pretty. To be a successful stock-broker takes nerves of steel and complete ruthlessness: in other words, to throw your humanity out the window.

Stock markets operate as reactive rather than pro-active entities. By definition, stock markets themselves are not supposed to "make news" but instead, are designed to react to it. Stock markets operate mainly on confidence. If they hear news of a war in an oil-producing country, they react with human nature: fear, and the values of stocks and shares suffer. If they receive news of positive jobs figures, they react with confidence, and so rise.

The growth of the financial sector in the last thirty years has seen the financial sector have more and more influence on politics, with governments breaking down decades of regulation on the power of the stock market. Ronald Reagan's chief of staff was a former financial chief. Even Obama's government has been called "the government of Goldman Sachs"; George W Bush and Bill Clinton were similarly in awe of the financial sector. The same can be said of Thatcher's government, and every UK government since. But Why?

For the past thirty years there has been a conventional wisdom that "the markets know best", therefore it is best to do whatever you can to indulge them. By indulging the wishes of the financial sector, governments sold into the argument that this would feed an endless cycle of economic growth.
We now know that this is a simplistic fallacy. The "growth" that was created by deregulating the financial sector, instinctively feeding the growth in the stock market, was simply a credit phantom. The stock markets are fiendishly complicated to understand, but the stock brokers that work in them are just human beings, working to human nature. That aspect of human psychology is not complicated at all. Eventually, when that confidence trick was shown to be the illusion that it had been all along, the markets panicked. And so we had a financial crisis.

But the politicians' treatment of the stock markets in countries like the UK since that crisis has been difficult to explain rationally. The Conservative-led government seems to have a quasi-reverence for "the markets"; the government's policy has been to have an economic policy that should not upset "the markets". But the price of stocks and shares should not dictate government policy; that is to completely misunderstand the cause and effect relationship between the stock market and reality. Stock markets do not create the reality, they react to it. The dog is supposed to wag the tail, not the other way around. But the Conservative government do not intellectually understand this fundamental truth.

Gordon Brown's government were also guilty of this fatal error at times, but the Conservatives under chancellor George Osborne make it almost official government policy. In Greece and Italy, their technocratic governments have also held themselves hostage to "the markets". This is intellectual madness, where the financial tail wags the government dog. What is more extraordinary is that this takes place after an almost apocalyptic financial crisis. The whole financial sector was seen to be utterly incompetent; yet governments across The West have decided to effectively hand over national economic strategy to financially discredited banks, and their financial growth strategy to a stock market that has the collective psychological mentality of a five-year-old.

Now that Greece is effectively a commercial colony to the ECB (itself effectively ran by Germany), the fate of a country of more than ten million people (and the "cradle of democracy") is in the hands of the stock market.
These days, "conventional wisdom" has logic turned on its head: when governments are subservient to markets, it is the same as doctors asking patients what they think their diagnosis should be, and asking patients what they think their remedy should be. Yet this is the counter-intuitive world that we are living in: where lowering taxes on the rich is supposed to help the poor; where cutting government investment and jobs is supposed to encourage a more positive economy.

It seems that there must be a government department where an advisor comes up with an idea and the minister asks: "Does is make any sense? No? Then it's probably the correct thing to do!"

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