The pol­i­tics of fi­nan­cial volatil­ity

The Pak Banker - - OPINION - Alexan­der Fried­man

TWENTY-FOUR years ago, in the midst of an ugly US pres­i­den­tial cam­paign, Bill Clin­ton's cam­paign man­ager neatly summed up his can­di­date's mes­sage: "It's the econ­omy, stupid." To­day, as in­vestors strug­gle to un­der­stand what is driv­ing ex­treme volatil­ity in the fi­nan­cial mar­kets, there is an equally pithy ex­pla­na­tion: It's the stupid pol­i­tics. Cen­tral bank poli­cies have moved from sup­port­ing the mar­kets to po­ten­tially desta­bi­liz­ing them. Now mar­kets are turn­ing to struc­tural re­form and fis­cal pol­icy for as­sis­tance. In this light, cur­rent price move­ments should be viewed through the spec­trum of geopol­i­tics. And it is not a nice view.

Nowhere is this more ev­i­dent than in the oil mar­kets, where prices have col­lapsed, with both Brent and Crude now hov­er­ing around the $30per-bar­rel level. The ex­tent of oil's fall, and con­se­quent de­fla­tion­ary fears, is cited as a ma­jor fac­tor be­hind over­all mar­ket tur­moil. In Jan­uary, the cor­re­la­tion be­tween crude oil prices and the S&P 500 reached the high­est level since 1990. It has be­come in­creas­ingly clear that sup­ply dy­nam­ics, rather than fall­ing de­mand, ex­plain the drop from $110/bar­rel since the sum­mer of 2014. The shift to com­pet­i­tive pric­ing im­plied by the break­down of Saudi Ara­bia's mo­nop­oly power, to­gether with OPEC's de­sire to counter the threat from US Shale en­ergy, drove the first down­ward move. Like­wise, the re­cent lift­ing of sanc­tions on Iran, and the re­sult­ing in­crease in global oil sup­ply, prompted a fur­ther 9 per­cent price drop over a mat­ter of days.

Th­ese sup­ply dy­nam­ics are shaped by pol­i­tics. Daily head­lines about po­ten­tial co­or­di­nated mea­sures by the key oil-pro­duc­ing coun­tries fuel oil-price volatil­ity and de­fine risk ap­petite across fi­nan­cial mar­kets. Yet the pol­i­tics is so con­fused that co­or­di­na­tion ap­pears un­likely, at best; the Ira­nian oil min­is­ter re­cently de­scribed a po­ten­tial OPEC pro­duc­tion freeze as a "joke." Iran's par­lia­men­tary elec­tions aug­ment the un­cer­tainty. Aside from oil, the other pop­u­lar ex­pla­na­tion for to­day's mar­ket tu­mult is the eco­nomic slow­down in China, which many in­vestors have cited as the rea­son for slump­ing equity prices this year. But the slow­down, re­flect­ing China's tran­si­tion from in­vest­ment- led to con­sump­tion-driven growth, was widely ex­pected, and the 2015 growth fig­ure of 6.8% was within fore­casts.

The real prob­lem has been self-in­flicted pol­icy er­rors by China's political lead­ers. An il­lad­vised in­ter­ven­tion in the equity mar­kets in July 2015, fol­lowed by a poorly com­mu­ni­cated ex­change-rate ad­just­ment in Au­gust, led in­vestors to ques­tion the com­pe­tence of pol­i­cy­mak­ers. Th­ese con­cerns have grown since the be­gin­ning of the year. Cur­rency pol­icy re­mains con­fused, while newly in­tro­duced (and soon with­drawn) stock-mar­ket cir­cuit break­ers have ac­cel­er­ated mar­ket falls, as in­vestors try to sell shares be­fore liq­uid­ity dis­ap­pears. More­over, pur­chases by state-owned fi­nan­cial in­sti­tu­tions, to­gether with bans on sales by large in­sti­tu­tional share­hold­ers, can­not re­main per­ma­nent fea­tures if the mar­ket is to be truly free. Ex­pected leader- ship changes - six of the seven mem­bers of the Polit­buro Stand­ing Com­mit­tee will be re­placed over the next 18 months - will only ex­ac­er­bate un­cer­tainty. La­bile pol­i­tics are in­creas­ingly driv­ing out­comes in other emerg­ing mar­kets as well. In Brazil, the govern­ment strug­gles to bal­ance its pop­ulist agenda with lower com­mod­ity prices, dwin­dling growth, and per­sis­tent in­fla­tion. More­over, a cor­rup­tion scan­dal has par­a­lyzed re­form. Small won­der that Brazil's stock mar­ket has fallen 28 per­cent since last May. In Rus­sia, too, pol­i­tics has ag­gra­vated the neg­a­tive oil­price shock. Western sanc­tions have con­trib­uted to an al­ready slow­ing growth tra­jec­tory, and are threat­en­ing Rus­sia's abil­ity to raise debt cap­i­tal in global mar­kets. The ru­ble has plum­meted 130 per­cent since 2014 be­gan, and GDP in 2015 con­tracted by 3.7 per­cent. Yet Rus­sia is a star per­former com­pared to Venezuela, where Pres­i­dent Ni­colás Maduro's govern­ment has over­seen the econ­omy's to­tal dis­in­te­gra­tion. In­deed, an­a­lysts are declar­ing the coun­try is past the "point of no re­turn." Even the rel­a­tively dy­namic In­dia is strug­gling, as its ex­cit­ing re­form agenda is chal­lenged by so­cial protests. In Europe, the ef­fi­cacy of the Euro­pean Cen­tral Bank's mon­e­tary poli­cies is wan­ing as the political scene be­comes in­creas­ingly frag­ile. In the United King­dom, polls show the June 23 ref­er­en­dum on con­tin­ued Euro­pean Union mem­ber­ship will be ex­tremely tight - an ob­vi­ous threat to mar­ket sta­bil­ity, re­flected in the im­me­di­ate sell-off of pounds.

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