The Tremonti Plunge

In recent weeks we have frequently cast our wary eye in Italy's general direction, as we sensed that the crisis may be about to migrate there (see, 'Et Tu, Italy?',  'Out Of Control' and 'Mamma Mia' for details). In 'Et Tu, Italy?' which we posted in late May, we wrote that 'at present, no-one seems especially worried yet' [about the prospect of a credit rating downgrade for Italy], an assessment that was confirmed by the complacency  exhibited by many mainstream analysts, of which we cited a pertinent example. Such complacency in the face of a clearly discernible deterioration in the market data is always a red flag to us (people should probably exercise caution in their dealings with Italian banks).  Even when our most recent post referencing Italy's growing problems was published –  occasioned by the solid technical breakout in 10 year government bond yields and the continued decline in the share prices of major Italian banks –  the world at large had not yet focused its attention on the situation. That changed a mere few hours later.

The specific development that the popular media thought most worthy of attention was the political fate of Italy's 'economy minister' Giulio Tremonti.

We would like to point out on this occasion that if an 'economy minister' truly wanted to serve the interests of the economy, he should as the first order of the day following his appointment tender his resignation and demand the disbandment of his entire ministry and its attendant bureaucracy. Alas, Tremonti is actually the 'minister of economy and finance', so he would actually be better described as the finance minister. 

It can not be denied that Giulio Tremonti has stood out by insisting on the enactment of politically unpopular measures aimed at extracting Italy from its debt trap. It would normally be laughable to assert that the financial fate of an entire nation hinges on the person of a single cabinet member. However, it is certainly a measure of how tenuous economic confidence has become if observers do in fact maintain this to be the case.

As Bloomberg reported on Friday:

“Speculation is growing that Italy's Economy Minister Giulio Tremonti – credited with shielding the country from the euro zone debt crisis – will soon be forced out of government, which would further raise the heat on Italian bonds.

The yield differential on Italian 10-year bonds versus safer German bunds hit its widest since the launch of the euro on Friday, as the markets worried about contagion from the Greek debt crisis.

Tremonti overcame cabinet resistance to push through a tough austerity programme last week, but now looks increasingly isolated and appears to no longer have the full support of Prime Minister Silvio Berlusconi.

"He thinks he's a genius and everyone else is stupid," Berlusconi said in an interview with Repubblica daily on Friday.

"He is the only minister who is not a team player," Berlusconi said, adding that he would make sure the austerity package was changed during its passage through parliament to make it more attractive to voters rather than markets.

It seems questionable whether the package is even that attractive to markets, however. It was not formally presented until a week after it was approved by the cabinet, and it has been marred by confusion over the measures it contains and how much they are worth.

The premium investors demand to hold Italian 10-year bonds instead of safer German bunds jumped to 2.24 percent from 1.99 percent on Friday. The Italian yield of 5.3 percent is the highest since 2002.

Yet analysts have no doubt the picture would be even worse without Tremonti, who has many critics but whose insistence on keeping a lid on the fiscal deficit is widely seen as having so far shielded Italy from the worst of the euro zone debt crisis.

"There's already growing market focus on whether Italy can bring down its debt and if you add uncertainty about Tremonti being pushed out you get a very dangerous mix," said Raj Badiani of IHS Global Insight.

"It would be a really negative step that would make ratings agencies and markets very nervous."

Badiani said Tremonti's exit might change the "pecking order" of possible contagion from the euro zone debt crisis and soon see Italy looking as vulnerable as Spain.


(emphasis added)

To summarize the above: Tremonti was seen by market participants as a major cog in the up until recently quite popular 'containment theory', which has been variously embraced by analysts and trumpeted by EU commissars as a measure of the 'success' of the bailout strategies embarked on by the eurocracy. This theory held that due to an increasingly visible lessening of correlations in peripheral euro area bond markets and the associated credit default swaps, the eurocracy had succeeded in 'containing' the debt crisis to what today is known as 'GIP' – the trio of Greece, Ireland and Portugal, small nations the insolvency of which was deemed to be manageable.

We always believed this idea to be lacking in foresight and ignoring a fundamental fact of today's intricate web of financial and economic interconnectedness. It sounded analogous to the assertions of Hank Paulson and Ben Bernanke in late 2007 and early 2008 that the 'sub-prime crisis was contained'. What these pronouncements ignored was that one can not 'compartmentalize' the credit markets in this manner when a crisis strikes. The losses suffered in one area of the credit markets will perforce affect other areas of the credit markets, as market players begin to scramble to raise suddenly scarce liquidity. Since we live in an age of universally practiced fractional reserves banking with 'lenders of last resort' empowered to issue fiat money in unlimited amounts, nearly every participant in the financial markets is highly leveraged. Extant financial liabilities at all times exceed the amount of money proper and perfect money substitutes in the system by nearly an order of magnitude (in other words, there is far more debt outstanding than there is money to pay it with). When the rush to pay back debt is on, asset prices everywhere come under pressure, usually in a manner that mirrors the degree of leverage employed by market participants holding the assets concerned. As every seasoned market observer knows, intra- and inter-market correlations tend to increase markedly when such crisis situations become acute. In short: there is no such thing as a 'contained' financial crisis.

As a further comment on the Bloomberg article quoted above, it appears to us that Mr. Tremonti's fall from grace is directly related to the political and legal troubles that have lately ensnared his boss, prime minister Berlusconi. As Berlusconi openly stated, “he would make sure the austerity package was changed during its passage through parliament to make it more attractive to voters rather than markets”. In other words, Berlusconi is eager to bribe the electorate and buy votes by altering what are regarded as unpopular measures. To quote the infamous lover of Louis XV of France, Madame Pompadour on the topic: 'Après moi, le déluge'.

It is a fundamental problem faced by democracies that everybody tries to live at the expense of everybody else. Politicians have only limited spans of office, and their interest in maintaining the accumulated capital of the nations they govern is close to zero – after all, this capital is not their own property. Short-run pain is thus always avoided, regardless of the long-run consequences. No wonder the political class has seized approvingly on the ideas of the most dangerous economist the Western world has ever been blighted with, who once famously quipped that 'in the long run we're all dead'.

Berlusconi may well be underestimating how far away said long-run consequences of irresponsible short term oriented polices are. It rather seems to us that the long run consequences have arrived, and we're all still alive to 'enjoy' them.

Friday's continued blow-out in Italy's government bond yields is testament to this fact. On Friday evening, we went to a traditional meeting of a group of like-minded supporters of free markets and sound money, and in a conversation with a friend who is a fund manager in our neck of the woods, a thought occurred to us that is probably worth sharing in this context: when Italy's bond yields initially broke out to a new high, this fact was scarcely remarked upon in the financial press. Indeed, apart from ourselves and perhaps Mish, who also keeps a close eye on what is happening in Europe, most observers seemed to ignore the event. To our mind this actually underscores its significance. Any development the importance of which is not widely recognized, harbors a much greater subsequent 'surprise factor' – you could perhaps also say that its 'black swan coefficient' is greater than it would otherwise be, or in Italy's case it would probably be better to call it a 'gray swan coefficient'.

An interesting factor is also what Mr. Badiani quoted by Bloomberg above calls the potential 'change in the pecking order of euro area contagion' that the recent events are beginning to suggest. Hitherto it was widely assumed that Spain was more likely to 'fall' before Italy, but this may no longer be true.

As a final comment on Tremonti, he was apparently caught on tape last week calling one of his cabinet colleagues a 'cretin' (video). The subject of this description was Public Works minister Renato Brunetta. We don't know Mr. Brunetta and can therefore not really say whether he is or isn't a cretin, but since he is 'Public Works' minister (this type of ministry sounds like a leftover of the Mussolini era), it seems likely that he was resisting Tremonti's budget cutting efforts. Moreover, most politicians are cretins by nature of the occupation as such, so the probability of a specific member of the political class actually corresponding well to this description must generally be considered to be quite high. As we have pointed out previously, we think a politician's entertainment value is the most important criterion by which to evaluate him. There are a few notable exceptions to this rule in countries where classical liberalism still has a constituency, and we would name Ron Paul as the best example for such an exception (i.e., we value him for his political agenda and honesty rather than his entertainment value) – click for higher resolution.



Italy's 10 year government bond yield – a strong breakout from the bullish consolidation over the past six months. According to Italy's prime minister Berlusconi, it's all the work of 'locusts' – his term for financial market speculators who of course are right after the rating agencies the people politicians are most eager to blame for the problems their policies have caused – click for higher resolution.



A long term version of this chart shows that yields have now also broken out over the 2008 high at 5.153%, which was made back when the ECB was still in rate hike mode, shortly before the 2008 financial crisis went into its acute panic phase. It is also notable how far this yield has now risen above the 2010 spike high made in the context of the first iteration of the euro area debt crisis when Greece's insolvency first became obvious – click for higher resolution.



Deficit hawk (sort of) Giulio Tremonti – on the way out?

(Photo via:



Bank Stocks Smashed Again

As the drama in Italy's government bond market unfolded late last week, in a related market development that we have kept an eye on for some time, Italy's banks took yet another step further into the abyss.

As Bloomberg reports:

UniCredit SpA (UCG) and Intesa Sanpaolo SpA (ISP), Italy’s biggest banks, fell to the lowest in more than two years in Milan yesterday as contagion from Europe’s debt crisis threatened to spread to the region’s third-largest economy.

UniCredit plunged 7.9 percent, the biggest decline since March 30, 2009, while Intesa dropped 4.6 percent. Both hit lows not seen since the period when markets were emerging from the crisis spawned by the collapse of Lehman Brothers Holdings Inc.

Investors are concerned Italy is moving too slowly to curb its public debt, as political infighting threatens to delay a plan to push deficit-cutting measures worth 40 billion euros ($57 billion) though Parliament later this year. Italian bonds dropped for a fifth day, driving 10-year yields to a nine-year high. The extra yield investors demand to hold the securities instead of benchmark German bunds rose to the highest since before the euro was introduced in 1999.

Banks are being hurt by “concerns related to the sovereign-debt crisis, because they are the most exposed to the Italian government bonds,” said Massimiliano Romano, head of research at brokerage Concentric Italy in Milan. “The risks may further increase if bond yields remain at their current levels.”

Finally someone is saying it out loud. The reason why Italian bank stocks have been plunging to an extent reminiscent of the stock market declines experienced during the Great Depression is their vast exposure to Italy's government debt.

So much for the alleged advantage of Italian government bonds being held largely by domestic investors. Said domestic investors are probably none too happy about this fact at the moment (it should be noted that back when the 'yield convergence' trade was all the rage in advance of the euro's adoption, the prices of Italian bank stock shot up in a fashion reminiscent of the Nasdaq bubble's ascent in 1999/2000).


The share price of Unicredito, Italy's largest bank, tumbles further. Last time we showed this chart we said 'it's only one bad hair day away from hitting a fresh low' – on Friday, said 'bad hair day' arrived. The stock has now lost 40% of its value this year alone and is so far down 80% from its 2007 high. Ironically, this means it is actually one of the best performing bank stocks in Italy since 2007 – click for higher resolution.



The share price of Intesa Sanpaolo, Italy's second largest bank, also ended the week at a fresh post-Lehman crisis closing low. And yet, this is actually also one of the better performing bank stocks in Italy – click for higher resolution.



Banco Popolare's share price has now actually declined below its 2008-2009 crisis low. It is now down an incredible 70% this year alone and has lost almost 95% from its 2007 high. As we noted previously, technical analysts will soon need a microscope for this one – click for higher resolution.


540 year old Banca Monte Dei Paschi di Siena is another bank stock that is currently trading below its post Lehman crisis low – down 'only' about 50% so far this year, if has also lost over 90% of its value since 2007. Interestingly though it failed to make a new low on Friday – click for higher resolution.



For all we know, there may be a few buying opportunities shaping up in Italian bank stocks. Alas, one must be very careful with trying to 'bottom fish' in what has so far proved to be a sheer bottomless well, especially in light of the still evolving sovereign debt crisis. Consider for instance the stock of Banco Popolare depicted above. Based on the fact that it once traded at € 24.50, a putative bottom-fisher may have thought that the stock was probably a bargain when it hit € 2.45. After all, it had lost 90% of its peak value at that point. Alas, anyone buying at € 2.45 is currently nursing a loss of 42%.

One the way down in a major bear market, it is not unusual for stocks to lose over 90% of their value many times over. EWI recently cited the example of Fannie Mae in this context, where various phases of the stock's decline were measured, from the interim highs to the interim lows it made while traveling from its 2007 high of about $70 to its current share price of about 25 cents. This was comprised of a whole series of declines of 90% or more. All in all the stock's decline now amounts to 99.65%. It's a Mandelbrot world.

Nota bene, we are not equating Italian bank stocks to FNM here, we are merely using it as an example to point out how dangerous the attempt to catch  falling knives in a bear market can be. It is only natural to wonder about the potential for a buying opportunity when faced with such enormous price declines, but careful due diligence and due consideration to the risks involved are extremely important. The nature of extended bear markets is such that the biggest percentage declines actually tend to occur in their latter stages. In fact, the Italian bank stocks depicted above demonstrate this principle nicely – Unicredito's share price has just declined by 21% in a mere five trading days. This is not only an unusually steep move for the stock of one of Europe's biggest banks, it is on the face of it all the more astonishing when considering how far the share price had already declined before this most recent debacle  – alas, it is very much in keeping with the tendencies generally observed in extended bear markets.

The above quoted Bloomberg article then recounts the reaction of Bank of Italy president and incoming ECB president Mario Draghi on the topic of where Italy's banks stand these days.

Responding to the market turbulence, Bank of Italy Governor Mario Draghi said July 8 he’s certain the country’s lenders will pass European stress tests by a “significant” margin.

Results of the second round of European stress tests will be released July 15, the European Banking Association said yesterday. Banks that fail this year’s tests may need to present plans for making up their capital shortfall by the end of September, according to an internal EU document.

Intesa, Monte dei Paschi di Siena SpA, Unione di Banche Italiane ScpA (UBI) and Banco Popolare SC (BP) have asked investors for a total of 10.5 billion euros this year to strengthen capital before the stress evaluations. UniCredit, which has raised 7 billion euros in the last three years through two securities’ sales, said it will meet stricter rules through its earnings.

Credit growth in Italy has been expanding at an annual rate of 6 percent to 7 percent, “which is the highest in Europe,” Draghi told reporters in Aix-en-Provence, France.”


The shareholder dilution induced by these capital increases has no doubt contributed to the weakness in Italian bank stocks – but we're not so sure what value investors should attach to the potential of these banks surviving the latest iteration of the 'stress test'. As we have previously pointed out (see the paragraph on the EBA (European Banking Authority) stress tests in 'Hurrah, we're saved again'), these 'stress tests' are highly questionable and appear to be more of a public relations exercise than a serious attempt to quantify the danger to banks if the debt crisis continues to go haywire. Underlying the criteria used in these tests is of course the assumption that the crisis will not go haywire. To quote again the decisive passage from an interview with an anonymous 'euro zone central banking source':

“"How many do we expect to fail? I would say 10 to 15," said one senior euro zone central banking source.

The EBA wants the number of banks that do not pass the tests to be around that level to show the examinations were serious, said a second source, adding the authority did not want to push for more, for fear it could spark panic.

"In order to demonstrate that it is credible, the EBA would need to show that the number of bank failures is significant, without being substantial," said the source. "A number in the teens is about right."

Zerohedge has in the meantime published a post that quotes a recent Moody's report on the EBA stress test, which apparently identifies 26 banks at risk of failing the test. However, the list of banks picked out by Zerohedge does not include the 11 banks (nine Spanish cajas plus the Hellenic Postbank and Malta's Bank of Valletta) that are not rated by Moody's at all. They are merely the banks currently rated below investment grade. As an aside, we have read the Moody's report, and while the so-called 'Group 1' banks are held by Moody's to be most likely to pass the stress test, the report does not state that it is certain that they will pass, but instead notes that any banks from this group that fail the test would be 'likely be downgraded in short order'.

The four big Italian banks the charts of which are shown above are currently rated 'investment grade' by Moody's and hence are part of the 'Group 1' banks that are deemed most likely to pass the test. Draghi will therefore probably be proven correct. It seems however highly likely that neither Moody's nor the EBA had a big deterioration in the value of Italian government bonds on their menu of options so far.

As an aside, we are not saying that Italy will eventually default on its government debt. Things are currently still far from that point, and whether Italy will join the 'GIP' trio and wind up  being unable to refinance its debt in the markets is not possible to foresee with certainty at this point. As a reminder though, the 7.5% range on 10 year government debt coupled with a yield curve inversion seems to be the current 'trigger' for euro area member governments to go belly-up. What we can state with certainty is that a continued rise in Italy's bond yields will put further pressure on the bond markets of all the euro area member nations currently identified as either already insolvent or in danger of getting there (a list that aside from the 'GIP' trio that is already financed by the EFSF obviously also includes Spain and Belgium). Moreover, it is possible that some currently not obvious candidates could suddenly find themselves in hot water as well. For instance, France's public debt-to-GDP ratio is closing in on the threshold where it may begin to attract unwelcome attention. Austria, which nominally has a slightly better debt-to-GDP ratio than Germany at the moment has a banking system that is dangerously exposed to a number of Eastern European nations. This exposure is highly profitable during boom times, but a huge pain in the neck during crises. Given the tendency of governments to bail out banks they regard as 'systemically important', there is a large potential liability for Austria's government should the banks get into trouble again (as an aside, one Austrian bank graces Moody's 'Group 3' list with a long term credit rating of Baa2, albeit 'stable').

Lastly, one must ask: if ECB president designate Draghi is correct that everything is just fine with Italy's banks, then what is it that the market sees? Admittedly financial markets are far from infallible – the 'efficient market hypothesis' is continually refuted by successful traders and investors who are able to spot and exploit cases of under- and overvaluation – but when it comes to weighing word from a bureaucrat against word from the market, we would tend to rather go with the market's judgment. Clearly the market is not particularly confident that everything is A-OK in the Italian banking sector, to put it mildly. Furthermore, the fact that Italian banks are at present expanding credit at a 6-7% annualized rate, the 'highest in Europe' as Draghi assures us, is not necessarily a comforting datum.



Mario Draghi, the man who for reasons unknown has actually volunteered to become the next ECB president. According to him, Italy's banks are just fine. Their share prices say differently.

(Photo credit: FAZ)



Italy, Economic Data


Current account deficit, millions of euro – click for higher resolution.



Current account deficit relative to GDP – click for higher resolution.



Italy's real GDP growth rate, quarterly annualized. 'Nothing to write home about' comes to mind. That is all Italy gets out of '6 to 7% credit growth'? – click for higher resolution.



Italy's government debt as a percentage of GDP (the 2011 estimate is probably understated; most recent estimates are for 120%). The word you're looking for is 'ouch' – click for higher resolution.



Italy's unemployment rate. Down from the crisis highs, but still far from the already elevated pre-crisis levels – click for higher resolution.



Italy's industrial production, annualized percentage change. The post 2008 crisis growth spurt is waning – click for higher resolution.



Italy's business confidence index.  An interesting contrast to the period immediately following the introduction of the euro – click for higher resolution.



Italy's consumer confidence index shows an even more pronounced contrast – click for higher resolution.




Italy's net government debt in billions of euro with an IMF forecast of the coming five years. While no-one can say for sure whether these forecasts will come true, this certainly doesn't look like it is expected that the public debt will come under control anytime soon – click for higher resolution.



5 year CDS on Portugal, Italy, Greece and Spain (in basis points, color coded). Portugal has shot to a new all time high of 1040 basis points, but the biggest relative move has been in CDS on Italy's debt, which have increased by a huge 110 basis points since mid May and are now approaching the high set in January – click for higher resolution.




Charts by: Bloomberg,,



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10 Responses to “Italy In The Spotlight”

  • I agree with what you say here – in fact, in the early days of this blog I have written extensively about the ludicrous propaganda put put by the establishment that blamed the crisis on the – actually non-existent, but only so-called, free market.
    When I mentioned EMH above, I certainly didn’t have Hayek in mind, but the likes of Fama etc. (Fama famously denied that there had ever been a housing bubble, by the way).
    It is true that there is a steady encroachment of semantic confusion. One example I have often mentioned here is that today, the term ‘inflation’ is widely used to describe what is really only one possible effect of inflation (namely, rising consumer prices). Alas, inflation really means ‘increase of the money supply’ – by using it to describe one of its effects, the establishment has managed to obscure the cause, and hence there is no longer any criticism of the cause. Central banks, in Orwellian fashion, get away with describing themselves as ‘inflation fighters’ as a result, even while they are in reality the very engines of inflation.

    • contulmmiv:

      “I certainly didn’t have Hayek in mind, but the likes of Fama etc.”

      Yes, I understood this all along. But the issue has never been Fama, but Hayek. The issue is _never_ this or that “Fama”, the issue is _always_ truth, the liberty truth entails, and the political opportunities to jugulate them.
      Once you begin walking in the footsteps of Fama, you walk in a minefield, because the opponents will not care about your subsequent disclaimers, but only by the fact that you lift the ball for them to strike where it really matters, namely Hayek…

      So, I would just refrain from addressing Fama in any way: why would I if, besides being wrong, his claims are so blatantly preposterous? Only to display “information” about “academic subtleties”? When I _know_ that Fama is _just a trap_, I would never even allow the discussion to go there, let alone bringing it there by my own mis-directed good faith…

      The point is that once one accepts the terms of the enemy, especially when these terms are his own distorted terms, one should not wonder why s/he looses the battle… Once one’s language has been stolen, one should invent a new one, I guess. Being on the defensive ( (out-explaining to death the ill-willed interpretations of X or Y… See Tom Woods…) is a loosing proposition. Be on the move, be a moving target, move the debate outside the field which has become familiar to the enemy (and where the enemy, in fact, took residence…), force new terms upon him which he isn’t prepared to meet, doesn’t have pre-packaged answers to, didn’t learn how to distort. “Indirection” should be the move, and not speeding head first into the wall…

      As I already wrote, I think the harm is already done… After this crisis, and after the devastation it has occasioned in the semantic field of free market theory (your examples above are two other forthcoming illustrations), I just _don’t know_ what it would take to restore it’s pragmatic function (actually I have some inkling, but this is too tentative and too private to talk about).

      It was “easy” (and I do not mean in any way to minimize the saintly courage of Hayek, Mises, Rothbard, which I am glad you brought about in your other comment), it was “easy” to theorize about the free market when the enemy theorized about central planning; it is much, much more difficult to do it today, when the enemy itself calls his central planning “unbridled free market” ! It’s a totally different job, which requires a higher level of cognitive sophistication and G. knows what else besides it… But _this_ is the job that is incumbent on _us_…

      Anyway, the topic we explored here occasioned me repeated…, let’s say, frustration, over the past three years and I am glad I found this place where I felt that the effort of explaining would eventually not be wasted. I believe I succeeded, at least in part, to send this important point across. Further on, the said “point” is on its own. Maybe it will stick, maybe not… I thank you for the occasion your conversation offered. I wish you a regenerating weekend, M.

  • roger:

    This is certainly gold:
    “EMH is a tautology. It defines the market as supremely rational and efficient, therefore no one person or bureaucratic cabal can ‘outsmart’ the market or allocate resources more efficiently. Price is truth, etc. Again, a tautology. Neither actually gives us actionable knowledge about how to make better decisions. Your argument is that all Enrons and Ponzis eventually are driven to zero, all cons are exposed, etc. Thus the market is always (eventually) right. But how much damage can be caused through the mispricing of risk before the collapse? Minimizing the damage is what we need to focus on now rather than whether the Free Market is the supreme value.”

    I actually embrace the idea that free market (Austrian definition) is the one system that will bring the pinnacle of human efficiency, but whether that can be maintained in practice over very long terms, it is questionable.

    If we start w/ the free market, the society invariably stacks up wealth (capital) & they become a more prosperous society. But as it has been shown time and again, a group of individuals inevitably excel much more than the rest. The nature of human is to preserve their existence. The excelling group will inevitably want to plant their existence firmly, eliminating the competition. Usually this ends up w/ the group through a multitude of means (fair & unfair, including deceiving the wider population) giving the state more & more power — and then the state in return buttressing the group, even in the condition that they are no longer the effective wealth producers. Then we end up again w/ the corrupt system that has to be broken down. Start again at square one. Basically this is a devolusion (opposite of evolution) from capitalism to the malignant forms of economic system (fascism, socialism, dictatorship & the likes) until the whole thing blows up & re-started.

    In theory, this can be avoided if most of the society understands well the proper concepts of economy & they are fair. But in practice, the will to excel over the others & self-preservation of one-self on top of the society, are far too strong. This is what always happens to the great economies through the course of human history.

    To run a perfect free market, the participants (humans) need to be in their near idealized states. I would think that this is a very tough ask.

  • sandorgb:

    contulmmiv, enjoyed your comment. I am an anarchist by nature. Freedom and love. But I think you are looking at the free market from an idealized imagination rather than one grounded in the present moment. There is no ‘free market’ per se (except the one of your imagination). There are rules and regulations almost everywhere you turn. There are instances of non-coercive free-willed exchange of goods and services between neighbors and friends, but they are called ‘black market’ by mainstream economists.

    EMH is a tautology. It defines the market as supremely rational and efficient, therefore no one person or bureaucratic cabal can ‘outsmart’ the market or allocate resources more efficiently. Price is truth, etc. Again, a tautology. Neither actually gives us actionable knowledge about how to make better decisions. Your argument is that all Enrons and Ponzis eventually are driven to zero, all cons are exposed, etc. Thus the market is always (eventually) right. But how much damage can be caused through the mispricing of risk before the collapse? Minimizing the damage is what we need to focus on now rather than whether the Free Market is the supreme value.

    Let me ask you, why do you worship at the altar of efficiency? Have you ever critically questioned its value? There is a concept called ‘too much of a good thing.’ Drug users know this idea well. When the economy becomes too efficient, too leveraged for its own good, it becomes brittle, top heavy and vulnerable to supply chain disruptions. Slack is also a good thing when balanced with efficiency. Then you have some ‘give’ and a buffer mechanism against crises.

    And your idea that ganging-up, collusion, mafia states are anathema to this free market is laughable. You are living in fantasy land. Your ideal does not exist right now. Maybe within the confines of your house if you live by yourself, but that’s about it. Even in the household, there is constant need for cooperation, negotiation, coercion, leverage. As soon as you have 2 people, your free market ideals as you define them are gone in practice.

    The great political problem for us anarchists and libertarians and Austrians is that people do gang up. States are mafias. Many male humans prefer enforcing their preferences with the threat of violence, through the assemblage of large stockpiles of destructive weapons. You can’t have a free market under those conditions. You can’t have an anarchist utopia until stupidity, ego, greed, and excessive reproduction are erased or re-written out of the human DNA.

    The Market is the collective consciousness. It is human, all too human. It is only as wise, sound, and efficient as its participants. Even if you wiped away all the laws, rules and debt right now, the market would quickly re-create all of our financial problems because they are problems of perception, emotion and misguided risk assessments. The human species is in a war with itself against recognizing life as it presents itself to us rather than what we would like it to be. Denial and wishing are the breeding grounds for fraud and deception.

    Catalyse recognition in others and they will discover truth for themselves. Truth has no need of persuasion, merely the cultivation of our intelligence. EMH is an absurd fetish. Bubbles can last for years because people often prefer fantasy to reality. That is not efficiency! Yes, we know price seeks equilibrium and it is a beautiful equalizer. I am a trader, so I live by price action. That’s nothing special. It’s called Nature, Tao, etc. Life seeks balance. It’s not about how reason always saves the day. Reason is but one aspect of human intelligence, often the best tool for a particular task, but not always, and the one most consistently overrated by its adherents.

    Capitalism, as practised by present-day humans, leads to violent global cartels, resource depletion, pollution, toxicity, and desensitization. That’s what we face. It does no good, to interject, “But that’s not the fault of the free market!” Doesn’t matter, that’s the hand we’re dealt. Of course we would be better off without a central state and mafias and armies, but they exist, so your decision-making process better take account of them. The free market has not yet arrived. It is worth striving for. But we need to make headway with the infantile aspects of the species, lack and fear; and they will not respond to being browbeaten with reason and virtue. When push comes to shove, humans are programmed to start praying, clinging, fighting or fleeing. Time for another strategy!

    • contulmmiv:

      You raise some valid points regarding human nature, gregariousness and free markets, which is why I reply; but indications are that there is no depth of reflection on your behalf around those points. Which is why I will not address them. Perhaps you will want to ponder upon this notion: liberty and all things free are a product of of civilization, with all it entails, not of “nature”.

      It takes courage to stand for one’s convictions, and even more courage to stand for that which one is by birth (“I am an anarchist by nature”), to allow that particular possibility to become personal destiny. Your “realism” and cynical wisdom may have made your life easier, but I doubt they made it happier, since there is no happiness when one is at discord (at war, as it were) with himself. Cynicism is the outer expression of deep inner dissonances, and that’s why one is urged to post a blog comment when something irritates the cynical protective mantle ;) So laugh all you want, but I have ground to know that you are laughing at your truer and better self. Sorry for that. Best, M.

    • I agree that all the obstacles you cite exist; that it seems incredibly difficult to effect change; that the ideal of the free market is under constant assault and that the system currently in place – which I refer to as ‘state capitalism’ – is not a free market.
      And yet, people like Mises and Rothbard never gave up the good fight, no matter how hopeless it appeared to be. And trust me, it looked a great deal MORE hopeless in Mises’ times than it does today.
      That we will live to see anarcho-capitalism or something akin to it established as an alternative to the current status quo seems quite unlikely – but one should not give up, even if the odds seem overwhelming. It is in everyone’s power to help educate people around him, and with the arrival of the internet, a revolution in thought has actually begun. The debate is no longer fully controlled by the establishment.

  • contulmmiv:

    … I have a folder in my “Attacks against the foundations of free market” dossier titled “Even those who should know better”. Unfortunately, I had to clip this paragraph from your otherwise excellent latest post there:

    “Admittedly financial markets are far from infallible – the ‘efficient market hypothesis’ is continually refuted by successful traders and investors who are able to spot and exploit cases of under- and overvaluation”.

    This is one of the locus communis of anonymous, collective “thinking” copied without breathing from the “academic” discourse, one of those unquestioned semantic topoi in which, just like in a patch of quick sand, even the best intellects can get swamped…
    I wrote this comment in the hope that this was just inattention on your behalf to one of the “dirtiest tricks” that our nature plays against our better judgment.

    Allow me to ask, PT, why would you judge, with such finality, the validity of the “efficient market hypothesis” _before_ the intervention of those “able traders and investors” and not after? Which expresses _best_ the rationality of the market: its state as determined by the action of multitudes, imitating thoughtlessly one another, or the state of the market as it is determined after the most aware and rational participants have their say?

    What is “rational” about the markets is not that they are “rational at every instant of time”: but that they, and only they, in the spectrum of human endeavors, alongside only with science, always reach the level of maximal rationality.

    What is “efficient” about the markets is not that at every point in time their valuation is optimal: but that in the wider context of endless human folly, folly which makes the copious, albeit depressing substance of history, they always _minimize_ the necessary results of the said folly, namely, inefficiency, loss, destruction…

    The rationality of the markets, alongside their efficiency should be understood as a _corrective and steering mechanism_ which operates inside the viscous, inertial and decerebrated medium of blind limbic responses, the medium of “normal” human existence…

    The efficiency of the markets, their rationality, is a _nonlinear process_: and the non-linearity of the process is due to the fact that it takes place upon the background of endless, prevalent, casual, day-to-day human irrationality. Had this not been the case, we would not need markets to establish rationality: the world of man would be one of perfect, angelic rationality, where no markets were needed ;)

    (Going a bit beyond the immediate topic of this discussion, the fundamental error is one concerning knowledge: knowledge itself is not _instantaneous_ but, just as its derivatives, efficiency and rationality of action, knowledge itself is a process…)

    What is plain great about the free market is that it does not “compromise”, “negotiate”, “cooperate”, “congregate” because it’s end-state is the result of of the action of non-cooperative, independent and autonomous _thinking_ agents: and this is precisely that which makes of the market a “selection environment”, as I proposed in an earlier post (and this is also why collusion, ganging-up, corpor-ation, and combines are so harmful and incompatible with a free market – but this is a different subject).

    Only when one understands how markets achieve their rationality/efficiency function as per the above, then one can also understand why markets are efficient/rational “from time to time”, like when “able traders and investors” get to be “successful” or, indeed, how they can survive at all! The market is the only human endeavor in which “the minority of the ables”, those able with knowledge and reason, prevails and, indeed, survives: and in that, not even science alone can be of help…

    Friendly, M.

    • RedQueenRace:

      “Allow me to ask, PT, why would you judge, with such finality, the validity of the “efficient market hypothesis” _before_ the intervention of those “able traders and investors” and not after?”


      It isn’t as if all the “incompetent/less capable” folks act first and the “ables” come along behind them and correct things. Market prices reflect the actions (or absence of) both groups at ALL times. These are not independent events that can be identified. It’s possible you don’t mean the above literally but at any rate you are leading to a “begging the question” proof of EMH where we “know” the most able have had their say because the market is “optimally/efficiently/whatever” priced. One cannot make judgments like ” _before_ the intervention of those “able traders and investors” and not after?” without engaging in some form of circular reasoning if one attempts to indirectly deduce participation.

      I think you need to read a bit between the lines here. While PT’s statement with respect to EMH was quite broad I think his intent may be narrower (only he can say for sure). EMH says that NO ONE can beat the market on a consistent risk-adjusted basis and that was the aspect of it to which I saw Pater’s commentary relating as from an individual’s perspective, whether or not s/he can consistently beat the market is the only particular of EMH that matters. There is indeed evidence that contradicts this claim. Having “risk-adjusted” as a qualifier, something I suspect EMH proponents thought bolstered their argument, is quite amusing. In fact, study of the most successful traders show they consistently take steps to manage and limit risk and that can include doing nothing, i.e., not “intervening”, and there is no way to wait for that before judging.

    • I’m not sure if there is not a misunderstanding here. I refer specifically to the ‘EMH’ as espoused by the rational expectations school – I am definitely NOT saying that the free market can somehow be improved upon as a system. I have previously written on why I think the rational expectations school is flawed, specifically in the context of booms/bubbles. My example was Citigroup’s former CEO Chuck Prince – who knew, by his own words, that one day, the ‘music would stop playing’. And yet, because the lagged effect of the central bank’s monetary pumping of 2001-2002 percolated through the economy for a few more years, he refused to stop ‘dancing’ as he put it. In the context of financial markets, especially the stock market, the EMH asserts that ‘prices are always perfect’, as they incorporate the judgment of millions of market participants. As a corollary to this notion, EMH then asserts that therefore, it is not possible to be a successful trader or investor – since each individual market participant can not possibly know MORE than the millions dictating the current prices. Now, anyone who has lived as a trader or investor successfully will know, without having to prove anything, that this can not be true. The stock market is in fact quite frequently wrong, and often BLATANTLY so. Did Warren Buffet, George Soros or Jim Rogers just drop from the sky? How can they be successful if it is not possible for individual investors to ‘know more’ than the market at given points in time?
      Let me give you an example that might be even more convincing. In late 2007, the mortgage credit crisis was already in full swing – the first bankruptcies of hedge funds and subprime lenders had already occurred, and both Fed and ECB had pumped 100ds of biillions into the banking system for fear that the payments system would otherwise collapse. And yet, the ‘market’ paid $70 per share of FNM (since down by 99.6%) and $65 per share of ABK and $40 per share of WaMu. It was blatantly OBVIOUS to anyone with even a smidgen of experience and financial wherewithal that these prices were plain crazy. And yet, there they were. Certifiably irrational prices. It was one of the great moments in time to make a mint by putting on a few judicious trades. The market was in error.
      In fact ALL entrepreneurial activity is SPECULATION. There are those who estimate the future state of the market data better than others – they are either successful entrepreneurs or successful traders/investors. They live from the fact that market prices are in flux precisely because the majority is often wrong, necessitating a continual reassessment as time passes. As an aside, all ‘contrarian’ investment philosophies are based on this very idea, i.e. that the majority of market participants can at times be very wrong.
      Alas, I m NOT saying that it is somehow possible to improve on the free market.

      • contulmmiv:

        Look… The financial crisis occasioned a flurry of interventions discrediting free markets & capitalism on the ground that the crisis “proved” markets to be inefficient and irrational (the “animal spirits” were copiously invoked). The argument followed the same basic blueprint, concluding on some call for intervention and regulation, adoption of an ‘Asian” model of capitalism, of “social Capitalism”, etc. Greenspan, Bernake, Andrew Lo (the one of derivative research fame), Stiglitz, Krugman, Robert Shiller, Soros, Neal Ferguson, Steve Keen, Kahneman & Richard Thaler, even the wise duo of James Montier and Albert Edwards, or the astute trader Dannis Gartman, stepped on each other’s toes to make the point. In very few instances the names of Eugene Fama or Cochrane are even mentioned (usually, academics such as Krugman do that). Almost nobody bothers about fine distinctions between the rightfully ridiculed Fama version of the “efficient market hypothesis”, and the post-classic liberal theory of efficient markets which should be in large part credited to Hayek, and which says nothing more than that, overall, markets are self-regulating forms of order which, if left alone, are the best tools we have for an efficient allocation of resources via the price discovery mechanism. Since I do not plan on writing an essay on this, you will have to do your own research in order to verify the assertions above. But a good illustration of these distortions when they are finally appropriated by politicians, is this piece by Kevin Rudd, at the time (2009) Prime Minister of Australia.

        What we have here is an epistemic and semantic displacement mechanism: call the Hayekian version the “soft” efficient market theory, which is as good a theoretical representation of reality as one can get in the social sciences, and in perfect agreement with common-sense; call the Fama version the “uberstrong” efficient market theory, which is as bad an example of useless academic theoretical work as one can get in the said sciences, and even worse when it comes to its lack of common-sense. Take the ridiculous conclusions of the second to discredit the first and, by that, to push an ideological and practical-political agenda.

        The morality tale: there are two tactics of discrediting. One, is the old “calumniate, calumniate, something will have to stick”. The other one, is to propose such a preposterous version of the attacked object that the criticism of the caricature will discredit and destroy the original, while in the process exhausting the intellectual energies of its defenders, and fogging any common-sensical understanding of reality that normal people, observers of the “debate” may have, until they no longer know in what world they live…

        A perfect case in point of the particular semantic displacement here under discussion is a recent criticism of Hayek by Soros: Tom Woods subsequently agonizes to extricate the chaff from the wheat and to break Hayek free from the embrace of Fama and the likes of him (includes links to Soros’s comments and to more Austrian refutations of Fama).

        The irony makes it that Hayek himself spend a good deal of effort in demonstrating a similar semantic displacement in the case of the terms “individualism” and “liberalism” [Individualism and Economic Order; “Liberalism”, in New Studies, etc. – google, available online], showing how their original, classical meaning was corrupted to the point that “individualism” became a name of disgrace, while “liberalism” came to designate the opposite of what it originary meant… Today, “liberal” actually designates “socialist”, and a liberal in the classical sense of the term ends by either being branded as a reactionary conservative or, if not, by having to explain himself to death, until nobody bothers to listen any longer… While “individualist” few would dare to assume it as the badge of honor that it actually is…

        The damage is already done: just as Hayek’s effort did not change the meaning of the words already changed, no Tim Wood -style effort will change the damage which was perpetrated upon free market thinking by names like those in the list above, thanks to the help of Famas.

        Yes, there is “no misunderstanding” here: but there is “inattention”, as I originary proposed, on your behalf. Inattention to the _politics of discourse_, and to how academic “productions” can be used as weapons and instruments in political and ideological battles – battles in which, like myself, I believe you to hold a personal and existentialist stake. While the “dirty trick” which our nature plays on us is the blindness to this _political function of the language_ by means of which logic, ratiocination and argumentation in good faith are obfuscated and turned against themselves until they become a mockery, and instead of the clarity which they should bring, all one gets is murkiness and confusion.
        The political point of any argumentation is _besides_ the argument (at the _meta level_, if you care to be sophisticated), and it is this dark shadow that your comment casts apparently in lack of awareness that I wanted to make you attentive at – or, to put you at-tension with, as my friend and master, the late HSK, would have had it ;)…

        I hope this will be of help. Friendly, M.

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