Monday, April 21, 2008

Bad Markets!

Since our last meeting, there have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability. We continue to monitor exchange markets closely, and cooperate as appropriate. G7 Statement Apr. 11, 2008

I don't have the impression that financial markets and other actors have correctly and entirely understood the message of the G7 meeting. Jean-Claude Juncker: Chairman of the Eurozone Finance Ministers' Group Apr. 17, 2008

As a parent, I sometimes find myself, when speaking to my son, starting sentences with, "Didn't I just tell you..." I get the sense Mr. Euro, Jean-Claude Juncker, is just itching to say, "Bad markets, bad, bad markets- we told you what we wanted you to do and you didn't do it."

Of course, financial market participants are not the children of the G-7 governments, although the more they feed at the trough of the states, the more likely will the states feel justified in the age old parent-child argument, "so long as you live under my roof, you will follow my rules."

Liquidity, apparently, comes with strings attached.

In defense of those recalcitrant financial market participants, perhaps, as children are wont to do, they focused on different aspects of the statement.

To wit: 1) We reaffirmed our strong commitment to continue working closely together to restore sustained growth, maintain price stability, and ensure the smooth and orderly functioning of our financial systems. We welcome the coordination by major central banks to address liquidity pressures in funding markets and recognize the importance of their coordinated actions to address disruptions in global financial markets. In particular, the recent steps taken by some central banks to expand access to central bank lending facilities and expand the range of collateral that they will accept is providing liquidity to financial institutions and helping to support improved market functioning. In addition, we welcome other measures that have been taken including monetary and fiscal policy that aim to give support to underlying economic activity and ensure price stability. Each of us remains committed to taking action, individually and collectively as appropriate, consistent with our respective domestic circumstances.

2) The turmoil in global financial markets remains challenging and more protracted than we had anticipated.

So, the children think, Mommy and Daddy are mad, but they'll let us keep playing and not send us to our rooms, and didn't they just admit they got it wrong?

Few things fortify institutional credibility more than identifying and riding the prevailing trend- think Greenspan's Fed and the Tech and Housing Booms- while few things destroy that credibility than fighting the prevailing trend.

And the trends prevailing today are the unwinding of those booms that fortified faith among both financial market participants and the general public in the wisdom and potency of the financial market managers.

Mr. Juncker, et. alios, can cry foul all they want but the discovery of faith misplaced almost inevitably leads to volatile behavior as the warning signs, so long ignored when faith was strong, now seem much more ominous. Teddy Roosevelt may have thought a big stick was sufficient, but no stick is big enough when you get things wrong.

And hey, what's wrong with volatility?

Aren't the markets price discovery mechanisms? If the G-7 can't figure things out, perhaps some markets are very mispriced? If so, isn't it better to find the right price(s) sooner rather than later?

But "better" is a relative term. It might be better, over the longer run, for the general public if radical mis-pricing was corrected quickly. It won't, however, be better for those who built their reputations, and continued occupations, on maintaining previous trends.

And that's the rub, ain't it?