Are the financial speculators the real winners of the crisis?
The crisis is not just making losers. The point is that financial speculators are continuing to play on the collapse of the euro zone by fuelling and speculating on the problems being experienced by some countries in Europe.
Since the beginning of the year, financial speculators have once again been in the spotlight. Admittedly, this is not the first time that speculators have been asserting their power on the markets1, but what is happening at the moment is once again completely irrational. In reality, those who caused the financial crisis are busy benefiting from it, while speculating on the long-term viability of the public finances of the States from which they have received guarantees to rescue that very same financial system.
Thanks to the effort made to ward off the collapse of the financial markets, but also for the sake of restoring the economy and putting right the serious social damage caused by the recession, public finances in most European States are currently being squeezed.
The statistics in the three tables below give a very stark and alarming overview of the current economic situation and the short-term forecasts of the four euro zone countries targeted by the financial speculators2.
Speculation in action
Before looking in more detail at how financial speculators behave, let us first define what we mean by financial speculation.
Financial speculation consists of a set of operations to purchase and sell financial or monetary securities with the objective of turning a profit from them thanks to the variation in their rates.
In practice, the speculator is betting on the movement of the rate of a security over a short or even very short period, compared to the traditional financial investments, for the sake of making money as quickly as possible. In addition, whereas for a ‘traditional’ investment we have solid forecasts and statistics, the key element in any speculation is subjectivity, specifically the use of forecasts which do not rely on solid statistical foundations.
The conduct of the speculators is frequently self-fulfilling: they choose to bet heavily on the loss of a security, and those bets are what cause that very loss.
The speculation around the financial viability of Greece is a very clear example of this practice: speculators are betting on Greece’s inability to service its debts, and those bets are fuelling the idea that the country is insolvent, generating in its turn irrational behaviour or even panic among the economic players.
At the same time, speculators are betting on Greece leaving the euro zone. This activity drives the rate of the euro down, and inflates Greek lending rates over two years to a level twice that of the average emerging country.
The Financial Times reports that there are over 40,000 contracts worth more than 7.5 billion dollars betting on Greece leaving the euro zone and the euro tumbling.
Indeed, this sort of speculation is made possible because certain types of financial contracts and financial transactions are not effectively regulated or transparent. This is particularly the case on the market for Credit Default Swaps (CDS), which are insurance contracts designed to cover the buyer of a loan against the risk of non-repayment. The principle is very simple: the higher the risk of insolvency, the higher the price of the CDS.
Against such an uncertain background, many speculators are betting on an explosion in the price of Greek CDS, meaning that speculators are betting on Greece going bankrupt. Since October 2009, the Greek CDS has gone from 120 base points to over 400. These rises have been caused by rumours of an imminent application for support from the Hellenic Republic to the European Investment Bank and the International Monetary Fund. Even despite rumours which have proved to be groundless, the price of Greek CDS has rocketed and is continuing to rise. Another thorny factor is that over recent years, the CDS market has gained in autonomy vis-à-vis its fundamental values, which has further increased speculation – CDS are being freely bought and sold – as if people were taking out fire insurance in the hope that their house would burn down, without actually owning the property they were insuring!
As for the euro, in the space of three weeks or so its rating against the US dollar has fallen from 1.50 to 1.35. This nosedive in turn ‘justifies’ charging ever higher interest rates to Greece, as well as Portugal and Spain, which are basically the most fragile economies in the euro zone at the moment.
Without regulation, it’s a return to old habits
Far from underestimating the problem posed by the viability of the Greek public finances, we must not forget that the gross domestic product (GDP) of that country accounts for only 2.6% of GDP in the euro zone. That being so, the euro zone overall is entirely capable of providing all the necessary guarantees with regard to the non-insolvency of Greece’s debt. To fall for the temptation of the irrational patterns fuelled by the financial speculators would be to play into their hands. Even though the political context was very different, let us not forget that the insolvency rate of the State of California, which accounts for 13% of America’s GDP, had been regarded as high, without this having any significant impact on the dollar.
However, what is happening shows that in the absence of effective rules at European or global level, speculators are perpetuating the same activities taking reckless risks that lay behind the financial crisis in the autumn of 2008, for which we are still paying a high price today. Faced with such a situation, there is a need for a determined political response: Europe’s decision-makers must effectively regulate this area. This would send out a strong political signal to those who are playing with the financial and political stability of States and individuals.
For a long time now, the ETUC has been calling for European legislation in this area, because the consequences of financial speculations in not just economic but especially political and social terms are too brutal.
Europe’s trade unions believe that legislation worthy of the name must – among other things – guarantee that the market oversight authorities have effective and efficient powers, that hedge funds and private equities are regulated, that rating agencies are regulated (see box), that tax havens are scrapped and financial transactions are taxed, at least at European level.
At the European Parliament, several texts covering many of the problems flagged by the trade union movement are under discussion. Moreover, the recent statements by the new Commissioner in charge of the internal market with regard to a forthcoming legislative proposal for more transparent CDS is a step in the right direction. However, the ETUC will not let these issues slip from its grasp. On this score, in cooperation with other partners, the European trade unions have set up a campaign to raise awareness and mobilise support so as to contribute effectively to the debates underway.
To avoid a repetition of such a crisis, policy must prevail over the financial markets. The ETUC will be very closely watching the work ongoing at Parliament, to make sure that the European Union equips itself with strict and effective rules.
_______________________________________________
Notes:
(1) In 1992, the US magnate George Soros had speculated on the exchange markets and triggered the devaluation of the pound sterling and the Italian lira, also forcing them out of the European monetary system. The French franc had also been targeted, but the robust intervention of the Banque de France had repelled this speculative attack.
(2) Financial jargon now talks of ‘PIIGS’, a deliberately negative acronym coined to refer to the economies of Portugal, Italy, Ireland, Greece and Spain, which are heavily in debt.