I felt it was time I got to know the almighty. I mean, of course, the bond markets. For at their call, the governments of this world tremble. Before them, every knee shall bow. To fend off their wrath, Britain’s Chancellor of the Exchequer, George Osborne, has just presented the most draconian budget in living memory – a burnt offering on the altar of this god we call simply “the markets.”
So, over the past few weeks, I have been talking to traders, strategists and analysts in London’s bond markets. Let me say at once that I am a complete novice and amateur in this field. If you want expertise, read no further; turn instead to the Financial Times. If, however, you will accept me as your ordinary citizen’s emissary to Mount Olympus, read on.
The first thing that struck me was a Wizard of Oz effect. Pull back the curtain and you find, behind that giant figure with his booming, mysterious voice, a little man pushing buttons and pulling levers. Or rather, thousands of men (and a few women). Most of them, far from manifesting Olympian, god-like arrogance, seem even more terrified than the rest of us. Partly, no doubt, this is because they are paid to be nervous, but it is also because they better understand the very dangerous place we are in. And one reason they understand it better is that they know the danger comes also from themselves. For the financial markets are a classic example of what social scientists call a collective-action problem. Thousands of individual traders make decisions that are individually rational, at least in the short term, but collectively irrational.
An essential feature of financial markets is that those involved are simultaneously spectators and actors. George Soros, who has spent half a lifetime trying to explain this phenomenon to a wider world, said last week in London that “markets don’t reflect the facts very well, partly because they create the facts themselves.” In what Mr. Soros calls “reflexivity,” trends in the real world reinforce a bias in market participants’ minds, which in turn reinforces those trends in “a double feedback, reflexive connection.”
Realities create expectations, but expectations also create realities, and so on.
One analyst I spoke to developed a compelling metaphor of the bond markets now standing like skiers before the threat of a “sovereign avalanche.” A single government defaulting could initiate a chain reaction of further defaults, accelerated by the collapse of banks holding too much of that government’s debt. In short, a “sovereign avalanche.”
The difference is this: On the slopes of Chamonix, even if a thousand skiers peer nervously up the slopes, their fear will have zero impact on the probability of an avalanche. In the financial markets, it is the skiers’ fear that triggers the avalanche.
Obviously, for such an avalanche danger to exist, there had first to be teetering piles of snow up the mountain. While overheated, overleveraged financial markets did contribute to piling up the snow, they were not primarily responsible for it. Governments, companies and, not least, you and me – in our double role as consumers and voters – were the main pilers of the snow. What the bond-market analysts show you with staggering clarity is, in most (though not all) of the developed world, and especially in many European countries, a ghastly tale of two Ds: debt and demography.
