Sunday, July 05, 2015

The financial market as a magic carpet

(This is a "reaction to Greek no vote" blog.)

A financial market is like a magic carpet.
A financial market is like a magic carpet because it is sustained by the belief of the participants.
When these beliefs disappear, the market fails, and falls just like a magic carpet that has lost its magic.

You would think that most people would be very careful to keep "their" magic carpet flying.
Yet many people do not understand that their pension or salary are provided by the magic carpet.

The Euro is a big magic carpet. Yet some governments have been spending too much. In effect they have been removing some of the magic from the flying carpet. This makes the countries that are careful with their spending unhappy, as they know that the carpet will fall if the magic disappears. So although the Greeks are in a terrible situation (and share the blame with others in getting there), I would argue that part of Europe is seriously tempted to eject them from the Euro, if only to remind others that they better shape up, or else suffer a similar consequence.


Adrian said...

Ahh James, keep in mind that the chief beneficiary of countries like Greece, Spain, Portugal, Ireland, Italy and yes even France being in the Euro is none other than Germany itself, hence ejection of these is unlikely to occur. Exactly how do you think the German export miracle has occurred? Do you think the world would be buying so many German goods if they still had the DM? Of course not! The Germans have a vested interest in keeping weaker economies in the Euro to keep the value of it low so that they can sell their goods abroad for cheap.

To put it another way, would you pay CHF 80,000 for a Volkswagen Golf?

James Litsios said...

Hi Adrian,
Reading between the lines, I feel your uncertainty about the UK's competitivity and future. In the end, nothing is forever. So you should not worry too much. The magic of math is that depending on the type of the economic model, you could be better off being small or big. So both the EU and the UK still have their chance of having chosen the "better path". Still, you have forgotten to mention the cultural difference between the two. To simplify: German's have a work culture, the UK has a class culture. If I were to spend 80K CHF, would it be better to give it to the Germans, or the the British?
I would argue that class culture is investing in to positional status quo, while work culture is investing in to the future. The work will pay for my pension, not class. Therefore I am happy to favor the Germans.

Adrian said...

Hi James, it's actually not the point I was making, although UK competitiveness has continually struggled in the face of the long term productivity problem we have compared to some other countries.

The question is not so much whether you should give 80k to the Germans or the British, but whether you would give 80k to the Germans for something you could get from another country (excluding the UK, our automotive manufacturing industry is basically non-existent these days), for 25, 30, 50% less.

Most people look at the value proposition of the good they buy, some have a luxury association with a particular brand but from the perspective of a value car buyer, comparable cars from say Ford, Volkswagen, Toyota and Hyundai, the Germans can afford to charge a small premium for their "engineering pedigree" etc, but that small premium gets quickly wiped out in the face of a DM return and subsequent increase in the cost of the car/washing machine/microwave/whatever.

So actually my point was that, Germany can't afford a collapse of the Euro project. Their economy would be devastated by a return to the DM as the weaker countries currently serve to keep their goods cheap abroad.

James Litsios said...

So you are saying that the Germans gain from the cheap "Euro". (Everyone would lose from a Euro that falls apart, even countries out of the Euro). Given where we are, in this never ending crisis, and the only way out is devaluation or the miracle of new growth, you are right to say that the German's get a "devalued" currency ahead of others (compared to a DM that would be valued higher). Your point is well taken, it could be, that this need of devalued currencies is so much more important than the risk of currency implosion, that the Greek crisis is the lesser evils for the richer part of the Euro zone, and the game has only been to play it out for Euro zone political and financial gain. This brings us back to your last comment on one of my blogs: I am too positive in my analysis! That is probably true. Maybe I should change the title of the blog.