Friday, 19 February 2010

Evil speculators attack...

and the Spanish government calls in the secret services. Honestly, I first thought I was reading Private Eye or The Onion when I saw the news headline "Spanish intelligence investigating market attacks". Apparently, the PM and his friends are so tired of bad news, bond market sell-offs of Spanish debt, and the IBEX market index declining that they have called in the men in the trenchcoats. They are there to investigate if there is a conspiracy against Spain, led by the Anglo-Saxon press and evil speculators. Apparently, yield spreads widening to a ~100 bp over Germany seems so inexplicable to the ruling party that the only explanation possible has to be a conspiracy. My sense is that the truly astonishing aberration has been that yield spreads ever got as small as they were in the runup to EMU and for some years afterwards. It was as if only currency risk mattered for bonds, and sovereign risk had disappeared. Debt dynamics depend crucially on the growth rate, and even without any of the fraudulent accounting trickery that Greece engaged in, you can produce a holy mess if your expected growth rate gets very low. Given that EMU was and is the wrong monetary standard to facilitate growth ine Spain, Greece, and Portugal, there is nothing strange about the bond market starting to worry. Periods of economic chaos and political angst create an atmosphere ripe for conspiracy theorists. Germans during the hyperinflation of the early 1920s could watch Fritz Lang's film "Dr. Mabuse", in which an evil genius manipulates the stock market, cheats at cards, ruins innocent maidens, and prints money. Every political class has a breaking point when it starts to ignore reality and switches to fantasy explanations of what they see and hear. Roland J. M. BĂ©nabou has a brilliant new paper on "groupthink" (non-technical summary is here), in which he tries to explain why reality denial can emerge under certain circumstances (and why it is perfectly rational for individual agents). I think it would make for better reading on Zapatero's desk than anything that the spooks can come up with.

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