Financial Markets Are Stuck in the Doldrums

We haven’t had song lyrics in The Daily Reckoning for a while now. They used to be quite common. So clear your throat. Or don’t, because it’s a rock song by Fall Out Boy called Bang the Doldrums:

This city says…

Come hell or high water
Well I’m feeling hot and wet
I can’t commit to a thing
Be it heart or hospital

The city is of course ‘the City’ of London. Or Wall Street or Bridge Sftreet in Sydney if you prefer. The point being the place is in the Doldrums. The name is the best part of the song, so don’t bother looking it up.

The doldrums are a strip of water either side of the equator where winds can be sporadic. Sporadic in the sense that they disappear. Sailing ships used to get stuck there, slowly running out of food and water.

Anyway, in (our interpretation of) the song, the City is complaining it hasn’t got a clue what it’s doing anymore. It’s stuck in the doldrums. Financial marketscan’t commit to a thing’. They’re stuck in a sideways distribution. Even the US stock market is going nowhere, if you adjust for inflation.

It makes us smile to see people talk about new highs in the stock market. Or how QE pumped share prices. The S&P isn’t even worth more than it was in 2000 if you account for the effects of inflation.

Not many ships can survive 14 years in the doldrums!

There’s been plenty of ‘hell or high water’ in those 14 years. Two epic rallies and busts. The lack of commitment is concerning. One minute the market is in love with tech stocks, the next they’re ugly. Then there was the affair with housing and banks in the mid-2000s. That turned sour too. Now the market is back to tech stocks. Ex-girlfriends are as alluring as they are dangerous.

The result is financial markets are stuck in the doldrums, slowly going stir crazy. Just take a look at where they’re sending their best and brightest these days. Do they mimic Warren Buffett like Seth Klarman and David Einhorn? No. Do they macro-trade like George Soros and Kyle Bass, taking on governments and central banks? No. Do they short lying governments and companies like Jim Chanos? No. As the Wall Street Journal put it, those guys made their money the ‘old fashioned ’ way. They were vigilantes, detectives and mavericks. But that’s the past.

These days it’s a manipulation game. Wall Street’s best are to be found coming up with algorithms that front run their own company’s clients. And Wall Street’s creative types find ways to manipulate the orders of their clients to make them even easier to front run. The dumber traders just manipulate markets over chat forums. Or they take over their colleague’s desk while he’s sick and submit a LIBOR figure (a key global interest rate) that generates millions in trading profits on their own trading terminal.

There’s a reason for all the questionable activity. The City’s world is now no longer out of control. It used to be chaotic. Anarchy. And people could make money by making sense of things. Or getting lucky. Both were difficult.

Slowly, over time, the government has infected the City with control. It does so in all sorts of weird and wonderful ways. Accounting rules designed to favour government debt. Regulation and deregulation in specific areas. Bailouts and implicit bailouts. Government sponsored entities. Pension funds and sovereign wealth funds. Revolving doors at regulatory, private and academic institutions.

With all those changes came control over financial markets. Control over the flow of funds, how they could be invested and lately even how share prices are allowed to behave (go up).

That leaves financial institutions either being manipulative themselves, as they have been with LIBOR for example, or joining in on the government’s rorts like they did during the housing bubble alongside Fannie Mae and Freddie Mac.

In Australia, one of the biggest providers of funds to the financial system is the government created Super system — the ultimate form of financial control. You force people to save and tell them how to do it. Cue the banks getting involved in Super. Commonwealth Bank has positioned itself in the wealth management industry in particular.

Imagine the power wielded by governments and Super funds over each other. One has the power, the other has the money. As the villains would put it, together they could take over the world. Or just the Labor and Liberal party.

Over in Princeton University in the US they’ve done their bit to illustrate what happens when control, power and money get together. A study of 1800 US government policies between 1981 and 2002 discovered that America is not a democracy or a republic, but an oligarchy. Government policy is initiated, determined, manipulated and provided for the benefit of companies and rich people.

Not a surprise to you, maybe. But it’s a change to Director’s law — something Milton Friedman’s brother in law came up with. The middle class is supposed to get the benefits of politics because of their numbers. The rich are there to be taxed and the poor are there to keep the middle class ‘middle’. Progressive taxes tax the rich. Higher minimum wages stop the poor from competing for the same jobs. The big middle class sits pretty.

Yes, maybe a strong middle class, something politicians tout, is really a political (ie immoral) phenomenon. These days it’s companies and the rich that supposedly dominate politics and therefore the benefits of politics. That’s what the great ‘Austrian’ economist FA Hayek predicted. Interest groups put their man in office and he needs to be bought off with benefits for the interest group to get his vote. The rich can pay the most, so their man gets into office.

The result of an oligarchy? The rich get richer. You can see it in everyone’s favourite topic to talk about. Home prices in the US are diverging. $100 million dollar houses are setting records while the sub-primers got whacked.

But here’s the problem with too much government control and being stuck in the doldrums. You don’t actually go anywhere as a whole. The ship isn’t moving, even while it rocks. The pie isn’t growing.

US GDP growth for the first quarter of this year will be revised to a negative figure, according to Goldman Sachs and JP Morgan. It currently sits at an unrevised positive 0.1% according to the US government. And the expected revisions from the investment banks aren’t exactly small. -0.6% and -0.8% on an annualised basis!

A recession in the US could cause a real problem in financial markets. Another leg down in the market’s sideways distribution?

Despite the pretty dismal result so far, with markets and the economy going nowhere fast, the governments of the world have been banging the doldrums. They declare success over the financial crisis.

But people are getting sick of control and stability. It hasn’t helped them. It’s just like being stuck in the real doldrums on the high seas. Sure, you don’t get seasick. But you could get scurvy.


Nick Hubble+
for The Markets and Money Australia

Join Markets and Money on Google+

Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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