Volatility and spooking aren't exactly the same thing

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Last week, just before the Budget, the Guardian published this article about the ‘power’ of the bond markets over governments. Whether it entirely supports the contention that the government must at all costs avoid ‘spooking’ the markets is another question. Indeed, one trader made it clear that “What you really crave in this industry is movement, volatility”. It’s the opposite of what the government wants, but speculative traders thrive on it. Volatility, of the sort which is described as ‘spooking’, is what helps the speculators to turn small margins on huge trades into profits for themselves. Those speculators actually want the government to surprise them, in the hope that they are better placed to react than their competitors and make a killing – stability is boring and largely unprofitable.

As with so many aspects of the financial markets, the underlying issue is that markets created to fill valid social needs have been captured by people who are driven by a culture of greed and gambling. The government takes in peoples savings in return for bonds on which it offers savers a fixed long term interest rate; large institutional investors hold those bonds as part of pension funds and life insurance funds. For all of those players, market stability is a definite plus, enabling them to plan with confidence. But the gamblers and speculators who use those markets for their own purposes want no such thing; they want the sort of volatility in which they are each trying to second guess each other and from which some make a profit and some make a loss by making multiple large trades in rapid succession. Far from being ‘spooked’, they are actually delighted by what they see as opportunity.

The question we should be asking is not about how we limit what governments can or should do to keep the markets stable, but about what we need to do to control and manage markets in a way that they serve social needs rather than constrain policy options. To date, humanity has not found a better way of matching buyers and sellers than using markets, and markets perform a useful social function. There is, though, no such thing as a ‘free’ market: all markets work under a set of rules. The issue is who sets those rules and in whose interests they operate, and to what extent those markets should be allowed to become the playthings of gamblers and speculators rather than performing the socially useful function of facilitating exchange. What Reeves and Starmer have decided – like all the other Tories in the recent past – is that they are happy for those markets to be captured by selfish interests, and for those interests then to have a veto on what government policies are, or are not, acceptable. The argument that there is no alternative is merely an excuse to justify what their ideological perspective tells them to do anyway.

We shouldn't be driven by speculators

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The market for government bonds works in what looks to most of us a very strange way. Despite the newspaper headlines about rising interest rates, the interest rate is actually fixed for the whole term of the bond. What appears to make the interest rate change is that the bonds can be traded, and the price at which they are traded doesn’t necessarily bear any relationship to the amount which the government accepted into savings when it issued the bond or the amount which it is obliged to return to the saver when the bond matures. So a £100 bond issued at 3% for 30 years will cost the government £3 a year in interest, and the government will refund £100 at the end of the term. In the meantime, that bond may have been bought and sold many times at varying prices: for anyone buying at less than £100, the interest rate will look higher than 3% and for anyone buying at more than £100, it will look lower than 3%. But, to the government, it is always £3 per year. For any new bonds, the government might need to match the apparent interest rate being paid on existing bonds, but changes in the bond market price do not and cannot affect the cost of existing commitments.

It means that headlines about rises in the rate of interest increasing the cost of ‘borrowing’ and putting huge additional pressure on the government can be misleading. They only increase the cost of ‘borrowing’ on any new bonds issued, not on all bonds currently in existence, although one wouldn’t necessarily understand that from the headlines. There are a number of factors which have pushed the rate for new bonds upwards, not all of which are in the control of the Chancellor. Many of them are part of global rather than local trends. The extent of the impact of the required higher rates depends on whether, and to what extent, the government is obliged to issue new bonds to cover its spending. The Chancellor and government choose to believe that they have no choice in the matter, a conclusion which pushes them inevitably in the direction of austerity and/or tax rises, which just happens to suit their own ideological view. It isn’t the only view, though. As Professor Richard Murphy points out, the government could simply stop issuing bonds and wait for the price to fall, as it inevitably will.

Murphy isn’t alone in challenging the tyranny of the bond markets. There was a letter from another professor in Wednesday’s Guardian addressing the question of bond markets very succinctly. To quote Professor Kushner, bond traders “…strive to reduce long-term stability to short-term volatility in order to multiply transactional opportunities”; in other words the price (and therefore the headline interest rate) is very largely being driven by gamblers and speculators out to make a quick buck rather than by investors making long term decisions. A half-decent Chancellor would seek to isolate us from, rather than fall into line with, the interests of such casino capitalism. It really is time to challenge and smash the hold which these people have on economic policy rather than allow them to cripple the ‘real’ economy in which most of us live in order to satisfy their greed and selfish interests.

How real is paper wealth?

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‘The markets’ have reacted fairly predictably to Trump’s puerile attempt at a conjuring trick by registering some dramatic drops. The analysts tell us that this reflects their pessimism about inflation, interest rates, and economic growth, all of which are likely to be adversely affected by the trade war which Trump has kicked off. Whilst I don’t doubt that economists (most of them, anyway – there are always some who’ll take a different view) do indeed see Trump’s actions as a threat to economic prosperity, I wonder if that’s what ‘the markets’ are really reacting to. It probably would be the case if markets were doing what classical economics says that they do, which is matching capital with investment opportunities in expectation of future profits. But if those same markets are actually more about gambling and speculation, which is probably the reality behind most trading, then what really drives them is an attempt to second guess what other players will do in response to tariffs in the hope of turning a profit by making a better guess than those other players.

It underlines that share prices an extremely poor indicator of economic value; they often bear little relation to the value of the underlying economic assets which they nominally represent. And their volatility makes them a poor measure of the wealth of their owners. To take just one simple but current example, the share price of Tesla has plummeted since Musk got involved with Trump’s administration. He’s still a very wealthy man, on paper, but his total wealth is apparently a lot less now than it was a few months ago. In his case, the scale of things means that it makes little practical difference, but the question is whether ‘paper wealth’ is a sound basis for assessing anything.

That’s relevant in the context of the increasingly strident calls for a wealth tax here in the UK. Whilst the idea appeals to many of us, assessing the amount of wealth owned by an individual is not a simple or straightforward task, especially if the value of a significant component of that wealth can vary from day to day – or even hour to hour. And non-paper wealth – property, land etc. – is not easily realisable or assessable without being realised. What is easier to assess, albeit still difficult when the tax system is complicated and people can afford to pay expensive advisers (although both of those obstacles could be overcome by a government intent on fairness), is the income generated by that wealth including, of course, any increase in value from the date of acquisition to the date of disposal of any asset. We certainly should do more to tax the wealthy, but taxing the wealthy isn’t necessarily the same thing as taxing their wealth. Their income is a lot easier to get at.

Following the money

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Trump’s attitude to the stock markets varies. When the US stock markets are riding high, Trump is quick to claim it as a vindication of his brilliant economic policies. When they take a dive (as they have done a few times recently, usually in response to wildly fluctuating tariff policies), he claims that he doesn’t pay any attention to what the markets are doing. If his chosen indicator doesn’t show the result he wants, then (like Groucho Marx with principles) he has others.

Whether a stock market movement in a particular direction is a good thing or a bad thing depends on one’s perspective, but it really isn't a very good measure of economic success. For those whose wealth is measured largely in terms of the value of shareholdings – such as, to pick names almost entirely at random, Elon Musk or Donald Trump – a fall in share prices can suddenly make you look a lot poorer, whilst a rise can make you look a lot richer. So: from that perspective, rising share prices good, falling share prices bad. On the other hand, for a wealthy person who wants to acquire more wealth, falling share prices creates good opportunities to buy up assets cheaply, especially if you know, or have reason to believe, that any fall (such as that induced by an on-off tariff policy sending prices yo-yoing) will be followed by a rise. And that’s true, even if there is no insider trading happening.

It underlines one of the issues with a casino-style stock market. Traditional economic theory suggests that the stock market is a means of matching available capital with investment opportunities, but it’s long since become divorced from that (which is why the government’s floated suggestions of replacing cash ISAs with stocks and shares ISAs do not achieve the aim of getting people to invest in businesses). In a casino stock market, share prices no longer bear any clear relationship to the value of the underlying assets. For some investors, there is at least a partial relationship with expected future profit flows in the form of dividends, but day to day share prices depend mostly on expectations of the way those prices will move, with the gamblers and speculators more interested in making money from large and frequent trades on small marginal changes in share price than in the future prospects or dividends of the company whose shares are being traded.

The result is that there are a small number of people making a great deal of money out of Trump’s capriciousness. By what I’m sure is nothing more than complete coincidence, many of them will be among Trump’s donors and supporters. Who’d have thought it?

Vigilantes and gamblers

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The Guardian carried a story the day before the budget, wondering whether ‘bond vigilantes’ would punish Rachel Reeves with a Truss-style market meltdown. Curious word, vigilante, with at least three different connotations that I can think of. The first – showing my age – takes me back to watching Mr Pastry on the TV as a child on a Saturday afternoon. There was one episode where, misunderstanding everything as usual, he wanted to become a village aunty. It has a warm, cosy feel to it – the idea that kindly people are looking out for others. A more dystopian version is where gangs of vigilantes roam the streets imposing their own version of the law, by force if necessary, meting out punishment to those who refuse to comply with their rules. Somewhere in between the two lies the concept of people acting together to assist the enforcement agencies in upholding the law.

The ’bond vigilantes’ referred to by the Guardian don’t fit any of those categories. These are people who are looking to turn a penny by trading bonds, in massive quantities, with the intention of leveraging the odd few pennies here and there – multiplied, of course, by the millions of bonds involved. They are more akin to gamblers and speculators than law enforcement officers. They claim to be using their judgement on financial events, such as the budget, to guess as to whether rates of return will go up or down as a result. In truth, they aren’t really even doing that – they’re actually guessing about whether other traders will guess that rates will go up or down and placing their bets accordingly.

Bond market speculation isn’t like betting on the geegees though. When it comes to horses, the number and size of bets placed may affect the odds that the bookies will give you, but they don’t make the horses run any faster. In the financial markets, the bets placed directly affect the outcome as well. If enough people buy and sell bonds in a way which anticipates a rise in the rate of return, then the rate of return will rise, and vice versa. The sad part is that the neoliberal governments, of whichever party, with which we have been saddled for decades believe that things have to be this way, and they have no choice but to follow the dictats of the markets. Their power is constrained mostly by their own lack of imagination.

Following the money

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When I read in the Sunday Times that the Brexit campaign was largely funded by the wealthiest people in the UK but that the fifth largest financial backer of the Brexit campaign was a hedge fund manager whose fund had lost half its value during 2016 following Brexit, my first reaction was that there is such a thing as karma after all.  But then I looked at the detail…

According to the story, one of the reasons that the fund lost half its value was that it took excessively gloomy positions about the immediate impact of Brexit on the UK economy.  This story from the Independent provides more details of the way in which the fund concerned bet on Brexit being a bad thing for the UK economy.  The hedge fund manager predicted that UK stocks would lose up to 80 per cent of their value amid a recession and higher inflation following Brexit, and bet heavily on that outcome. 

Had he been right in his prediction, he would have made a lot of money for his fund as the UK economy tanked.  Unfortunately for him (although, perhaps, fortunately for the rest of us), the Brexit vote itself did not have as serious an effect as he predicted (although whether actual Brexit, if or when it happens, will let us off so lightly has yet to be seen), and the result was that the fund gained heavily in the first few days when it appeared that the predictions might be right, but then went on to lose a great deal of money.

So, to summarise, a billionaire who believed that Brexit would be extremely damaging to the UK economy nevertheless donated more than £870,000 to achieving precisely that outcome; an outcome from which, had he been right, he stood to earn a very large profit.  Am I the only one who wonders whether there might just be something wrong with a political system under which this can happen?

Winners - and losers

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Remember how, not so very long ago, the gamblers and speculators did their very best to wreck the Euro in their greedy attempts to turn a few pennies?  We were told often and bluntly at the time that we should count our lucky stars that we hadn’t joined the Euro project, and that it had been doomed to fail from the start.

Since the referendum on June 23^rd, those same gamblers and speculators have seen a new chance to turn a few pennies by betting against the pound, and the result has been to drive the value of sterling down.  Strangely, those same people who told us when this happened to the Euro that this showed what a disaster the Euro-zone was now seem to be telling us how wonderful this is for the sterling zone. 

Of course, the situation is not identical, but there is one clear point of similarity, and that is that the movements in currency aren’t being driven (despite what the news reports regularly say) by ‘investors’ making their wisest guesses as to what the future holds, but by gamblers and speculators who allow their computers to trade autonomously in pursuit of very narrow margins by repeatedly buying and selling the same things.  It’s a complete distortion of what ‘markets’ are supposed to be about, namely fixing the price at a level acceptable to both those who want to buy a product and those who want to sell it.  It’s gambling, pure and simple – and like all gambles, there are losers as well as winners. 

And, just as with the problems of the Euro-zone, there’s no need to guess who the losers are.

Getting away with robbery

Tweet Bankers' squealing about people being beastly to them is nothing new.  Nor is the idea that people earning vast sums of money for undertaking activities which are of dubious worth at best end up sincerely believing that their salary in some way reflects their ability or value.

But arguing, in effect, that they should be allowed to continue to bend or break the rules as and when it suits them, and take reckless short term decisions in the hope of making a quick buck, and do all that with impunity, is surely an illustration of how far they have become removed from the real economy in which most of us live.

I’m not entirely convinced that the proposals to claw back bonuses for up to seven years go far enough to rein in the gamblers and speculators who masquerade as bankers, but it’s at least a start.  The real requirement is for multinational action to bring the money markets back under control and make them work for society rather than for the bankers.  But the problem we face is that those making the decisions genuinely seem to believe that the crash was just the result of a few bad decisions, rather than an inevitable consequence of the way in which we have allowed people to turn markets into casinos.

All power to the speculators

Tweet I really don’t know where to start with the latest post from Lib Dem AM Peter Black.  One of the world’s leading speculators (described in the blog as ‘a world leading expert on currency’ – I thought it was tongue in cheek, but apparently it’s intended to be taken seriously) has said, in effect, that if the intransigence of the unionist parties in the UK forces an independent Scotland to create a new currency, it will leave Scotland open to attack by speculators who will see the new currency as weak and therefore an opportunity to destabilise a whole country in the interests of making a profit.

Well, of course, any small country with its own currency is open to the same sort of unprincipled attack at any time; it doesn’t need to be a new country.  And the “financial meltdown that swept through the Eurozone” didn’t happen by accident either; much of that was the result of speculation as well.  (Yes, of course the countries concerned had a few problems of their own making, but it only became a wider crisis because of the actions of the speculators).  Any country and any currency are open to such attack at any time, regardless of size; it’s not just a problem for an independent Scotland.

The speculators need to have a fear to play on of course – otherwise they don’t all act in the same direction, and their gambles cancel each other out.  But the story here isn’t really about Scotland at all – it’s about the power that our political leaders have ceded to the casinos which pretend to be markets.

And the political answer that we need isn’t – or shouldn’t be – “you can’t do that because the speculators will ruin you if you do”, which seems to be the conclusion of the blog post.  What we need is co-ordinated action to take speculation and gambling out of the equation; we need to curb their power not bend down before it.