Distrust between politics and markets
The dominant discourse of the 1990s and 2000s claimed that markets can do almost everything better than governments, and should thus be deregulated to realize their full potential. Then the financial crisis erupted in 2007/2008, and politics was suddenly asked to take center stage again.
The recent power struggle between politics and markets partly explains why we now find ourselves living in a world where these two spheres are so antagonistic towards each other. This has been especially true during the euro crisis: markets have crushed every attempt made by politicians to solve or mitigate it, claiming they are “too little, too late” and clearly not behaving the way politicians would want.
Why is there such a significant gap between what markets want and what politicians can deliver? There are several causes, in my view: the mutual contempt of the two contenders, their different senses of time, and the diversity of each party’s constituents.
Politicians have a long history of treating markets with contempt. French President Charles de Gaulle stated in the early 1960s that “the politics of France are not decided in the stock-exchange trading pit,” and by the early 1990s French Prime Minister Edith Cresson put it even more bluntly: “I don’t give a damn about the stock market.” This contempt extends well beyond France, with Eurogroup President Jean-Claude Juncker providing the latest example at the beginning of the euro crisis in March 2010: “We have to strengthen the primacy of politics. We have to be able to stop the financial markets. We have the instruments of torture in the basement. We will display them if it becomes necessary.”
But market participants are equally contemptuous of the political sphere, if we listen to financial press editors, analyst notes and financial media talking heads. How many times have we heard that politicians know nothing, and that they are unable or unwilling to grasp the problems? In one of his latest research pieces, one of my esteemed colleagues at a US investment bank even went so far as to question the usefulness of democracy in times of crisis.
Political time and market time
Markets speed ahead, while politics meanders: this fact alone can explain many misunderstandings. On paper, certain solutions to the euro crisis may appear rather simple economically, but they look hugely complex from a political perspective. In many countries, the national parliaments have to ratify the solutions and/or they must be submitted to popular referendums. In some countries, not least Germany, the legitimacy of new international treaties can also be challenged in constitutional courts.
Moreover, election cycles can shift political majorities. Since the beginning of the euro crisis, 12 governments in 10 Eurozone countries have already been ousted by general elections or lost confidence votes in their parliaments. With the recent elections in France and Greece, a new source of uncertainty has emerged for market participants: newly elected governments wanting to renegotiate what their predecessors approved.
What do markets want – and what do politicians want?
Politicians sometimes have a very difficult time working out just what markets want in the first place. In the euro crisis, for example, markets first punished certain countries for a lack of austerity – and then once these countries implemented stringent austerity programs, the markets turned around and punished them for a lack of growth.
But just who are “the markets”? They are far from a uniform entity. Market outcomes reflect a multitude of market participants with different, sometimes even contradictory, objectives and motivations. From pension funds and financial intermediaries to hedge funds, traders and private investors – even you and me as soon as we invest – markets are global and highly fragmented. But there is one common principle: everyone wants to make a profit, or at least not lose on their investments.
A variety of participants also marks the political process. Here we have heads of state and international bodies, various parliaments and ultimately – because we still have democracies in most of the developed economies – the electorate. Moreover, in the case of the euro crisis, there might be conflicting goals among the 27 members of the European Union or the 17 members of the Eurozone. Political players are also diverse, but here too there is a guiding principle: politicians want to get reelected and will only reluctantly put their careers in jeopardy.
No happy endings
Each political action will obviously cause a market reaction, which might or might not please the politicians. In the current euro crisis, the first thing European politicians need to acknowledge is that there can be no happy ending. Whatever the ultimate outcome of the crisis will be, either full fiscal integration with shared European debts or the disintegration of the euro, it will be costly for both the “weak” and the “strong” countries. Hence I am certain that more governments will fall before the crisis is finally solved.
Politicians who understand that their careers have only a remote chance of surviving the euro crisis might actually start to focus on solutions, which in turn might or might not please market participants. However, pleasing market participants is in the end not so relevant.
Jean-Claude Juncker’s bon mot “When it becomes serious, you have to lie!” is probably the worst thing that has been said during the crisis because it exacerbates the mutual distrust between politics and markets. In my view, markets prefer “bad” decisions from politicians as long as they are credible and transparent. This is far better than prolonged uncertainty or decisions that are taken to “calm the markets” but are neither credible nor sustainable in the long run.