Why am I holding Euros???

The most obvious question to oneself these days, especially if one's a fund or an institutional, is Why aren't we bailing out of Europe...If you're the client, the question to your advisor: Why are you holding on to Euros?  The obvious explanation is: cognitive dissonance. The hypothesis was advanced by  psychologist Leon Festinger (1957).It became popular among political pundits and business types quite rapidly when, years later,  Newell and Simon* integrated Festinger's insights into their own hypothesis concerning human problem-solving.

The Newell-Simon model as it is now labelled, named after Allen Newell and Herbert Simon,  describes how human beings make decisions, ie. solve problems. It becomes especially enlightening when it describes how people react during the intellectual logistics of problem-solving: the intelligence phase, design phase and choice phase.

How do investors react to conflicting attitudes: you hold Euros but everyone calls a crash.

Decision-makers, when in doubt,  will "listen" 'more' to information that supports their belief system than to information that disrupts or questions their belief system.  The underlying hypothesis is that the individual seeks to reduce dissonance or accompanying discomfort created by conflicting information that undermines his position. He will settle for 'satisficing' information without claim to making the optimal decision.

But in many cases, he will side with inputs that justify his original position. Of course, the more individuals are rationally bound (you don't have all the info) the more they will attempt to adjust in a timely satisficing way to the facts. If the former, You could be a die-hard and lose your pants and that of your clients, notwithstanding the information;  if the latter, you could be pragmatic, give yourself and others the benefit of the doubt, and bail-out. After all, the well-known economist and investor John Maynard Keynes evoked the perfect reaction to relieve the dissonance: "When the facts change, I change my mind. What do you do, sir?"

So why are some investors still holding on to the Euro securities...for the same reasons that some European leaders keep promoting austerity measures for public policy notwithstanding the adverse results being generated in  Greece, Spain and Italy.

The dissonance:
Firstly, even though things are difficult in Europe, they're difficult all-around the world. Some will argue that they're already overexposed in equities, in BRICs, in US and other sovereign currency-issuer securities, and even gold-it can collapse on a wind-shift....after which deliberation they move on and argue the next....

...Eurozone economies are not in as bad a condition as selected data suggest. It's quite reasonable to experience hiccups during 'policy transitions' after traveling over rocky roads. And Southern European roads are very rocky according to northern Europeans. Things will smooth themselves out over time. The worst case is if Greece defaults. Let it exit. Nudge Greece out gracefully. The Zone is saved.  This is the message that is being conveyed by European leadership as social tensions in certain countries become more forceful. If that doesn't work out as planned....they move on and argue the next....

...Europe is 'too big to fail'. (Remember Lehmann et al). The US and China won't let it happen- this is Europe, not some mismanaged bank. Some refer to this position as highly speculative; other would consider it quite realistic. Either way, their rationalization recalls Lord Byron's popular but mistranslated line found in his Childe Harolde's Pilgrimage :

   When falls the Coliseum, Rome shall fall;
   And when Rome falls--the World.'

The Eurozone rendition is "When falls the Euro, Europe shall fall; And when Europe falls---the World."

It would carry more credence if it was the US, however.

Here's my take:  If China's growth is projected downwards, if Germany's order book starts doesn't refill to 2010 levels (I don't think it will refill for a long while) and  growth in the US is revised downwards, then you should have bailed to liquid USD, until the facts change!!! If you didn't, think about it.

*I credit Fictional Reserve Barking, Oct 2, 2011, author (Circuit, ) and reader  (JHCraw) for the reference to Herbert Simon's work.

Europe! It's not too late to reverse austerity

Europe! It's not too late to reverse austerity 

The article is cross-posted on Fictional Reserve Barking.  We wish to thank the editor. Readers are invited to post comments on either blogs.

Months ago we outlined the challenges that presented themselves to Italy and Greece, and to Germany, France and the United Kingdom.  We opted against austerity, trusting that the technocratic appointments of Messrs Monti and Papademos could transform governments in Italy and Greece, and enable their respective legislatures to both recommend alternative and optimal public expenditure policies and to restrain policymakers from endorsing imposed fiscal restrictions while constraining budgets any further.

Unfortunately for the global economy and markets, Messrs Monti and Papademos initiatives did the contrary.  They aspired towards the heroic in adhering to a sub-optimal detriment and have now emerged as the scapegoats for political and investment désenchantées.

More ironic is that both men had very little to do with the original debacle.  They were recommended to their nation’s legislatures to clean up a mess.  Instead, as a result of attempting to implement austerity measures, they have generated more anxiety in world markets than expected.

Unfortunately, the recent economic deterioration and rising social tensions within their respective economies has become their responsibility, and the political disenchantment surfacing within the electorate is also their responsibility.  Worse still, the time for apologetics is long past and is now irrelevant.  At jeopardy is their leadership, the credibility they endorse for their visions of the future and the overall well-being of their citizenry.

Mr. Draghi and Mrs. Lagarde have voiced a redemptive message.  Both had professed that the worst was over.  For instance, in a speech on March 26 of this year, Mr. Draghi said the following:

“I would like to take this opportunity to provide you with my assessment of the current situation in the euro area and shed light on recent signs of improvements in the overall outlook.  I would particularly like to draw your attention to the effectiveness of the policy measures implemented by the Eurosystem, the EU institutions and national authorities.  And to remind you of the measures that we all must continue to pursue over the coming months and years with great diligence in order to continue on this path of stabilisation.”

As for Mme Lagarde, on March 18 of this year, the Managing Director of the IMF sought to reassure the audience of the 2012 China Development Forum with the following statement:

“There are signs that strong policy actions—especially in Europe—are making a difference. Financial markets have become a little calmer…”

Yet, Spanish yields are rising, as are those of Italy and Greece, and there is more and more talk of a potential third bailout for Greece although the IMF and the ECB have reassured the investment communities that changes in Greece are being introduced as promptly as possible and will be enacted effectively.

Any remnant stress in markets, according to the institutional duo is a result of the misperception by the interested communities that the consolidations proposed by the ailing economies cannot be achieved.

The emerging doubt on behalf of investment communities and investors in general should not be surprising.  After all, it’s their money and it’s their perception that underscores investment decisions.

One daresay that the investment community saw the collapse of the system much earlier than either the IMF or the ECB, although the leadership of the latter two has been proactive in attempting to stabilize investor sentiment and mitigate between some form of restraint and investment in growth and employment.  Notwithstanding, the reassessment that further bailouts will be necessary is now the swan song of European austerity politics.

Unfortunately, European policymaker perceptions of the bond markets are completely skewed as a result of their own biases.  What is difficult for them to appreciate is that there is no basis left for growth.  Unemployment is up, with Spain leading at 23.6% followed by Greece at 21.0%.  And in those Eurozone countries where unemployment rates are low, many of the employed are part-time workers and, as such, susceptible to labour volatility during these turbulent times.

Moreover, capacity utilization in the manufacturing sector over the last four quarters is dropping across the Eurozone at alarming rates.  Order books are not being filled as quickly as desirable, and their durations and size are shorter than required to support additional investments.  As a result, business investment is stalling as management constrains expenditures and saves its liquidity for dividends in lieu of growth to stabilize share values, foreboding that equity markets react adversely to this dilemma and possibly falter.

What most pundits expected from the emerging markets may not be realized: trusting that BRIC plug the slowdown in Europe, with China leading the way.  Unfortunately, there is no plug.  Most informed observers now mitigate between a slowdown and an ease in aggregate demand, with China’s future growth rates in question.  Projections for the region suggest that China’s growth potential could be in the midst of a major contraction with rates dropping to 7.5% from anticipated 8% and over.

Given the above, the most difficult challenge in domestic politics is for any Government to admit that it followed the wrong track.  There is no shame in being part of a bigger bloc of nations that propound fiscal consolidations even if austerity is showing itself as being the ineffective solution to the Eurozone’s financial crisis, a crisis which is now becoming an economic and political crisis.

It actually takes great courage in admitting that the austerity programs recommended may not work out.  The experiences of other nations in the matter, elicit danger signals that can’t be overlooked.  In such a case, the consolation is that if one’s admission is timely, the Government may come out of an unfortunate situation looking respectful and remarkably diligent.  There is still time for Europe to turn back its political agendas before turning the wrong corner.