MONEY, MARKETS, and DEMOCRACY
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MONEY, MARKETS, and DEMOCRACY POLITICALLY SKEWED FINANCIAL MARKETS and HOW TO FIX THEM GEORGE BRAGUES Money, Markets, and Democracy George Bragues Money, Markets, and Democracy Politically Skewed Financial Markets and How to Fix Them George Bragues University of Guelph-Humber Toronto , Ontario , Canada ISBN 978-1-137-56939-4 ISBN 978-1-137-56940-0 (eBook) DOI 10.1057/978-1-137-56940-0 Library of Congress Control Number: 2016955852 © The Editor(s) (if applicable) and The Author(s) 2017 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifi cally the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfi lms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specifi c statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the pub- lisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made. Cover illustration: © Mick Wiggins / Alamy Stock Photo Printed on acid-free paper This Palgrave Macmillan imprint is published by Springer Nature The registered company is Nature America Inc. The registered company address is: 1 New York Plaza, New York, NY 10004, U.S.A. In Memory of Fernando Bragues (1935–1987) Deixastes este mundo tragicamente cedo, mas nunca fostes esquecido nos meus pensamentos e trabalhos For Natalina Nazare dos Santos For Maria Bragues ACKNOWLEDGMENTS I thank my colleagues at the University of Guelph-Humber for their support in this project. I wish to recognize Clive Cockerton who, as an Associate Dean at Humber College many years ago, spearheaded the introduction of a course entitled “Money, Markets, and Democracy” which was the inspiration for this book. Special thanks to my wife, Maria Bragues, for the great patience and understanding that she demonstrated throughout the entire writing process. While signifi cant portions of the introduction and a few passages elsewhere are adapted from previously published work of mine, this book is not a repub- lication of earlier articles. That said, I have drawn freely on the following: “Voters and Debt” Financial Post (September 1, 2011) “The Politics of Financial Markets: An Introductory Discussion”, Global and Business Economics Anthology, Vol 2, Issue 1 (2010): 6–16 “Leverage and Liberal Democracy” in Lessons from the Financial Crisis , Edited by Robert W. Kolb, 1–8. Hoboken: NJ, John Wiley and Sons, 2010. “Freedom to Short”, Financial Post (April 19, 2006) “Futile Disclosure”, Financial Post (July 27, 2004) “Why Insider Trading Should be Legal”, Financial Post (February 13, 2002) “Free the Short Sellers”, Financial Post (November 19, 1999) vii CONTENTS 1 Introduction: Why the Markets Must Be Politically Investigated 1 2 Money Before Liberal Democracy 15 3 Money in Liberal Democracy 43 4 The Bond Market 75 5 The Stock Market 119 6 The Derivatives Markets 177 7 The Currency Markets 225 8 It’s All About the Money 275 Bibliography 285 Index 309 ix LIST OF ABBREVIATIONS ABS Asset-Backed Security BIS Bank for International Settlements CDO Collateralized Debt Obligation CDS Credit default swaps CFTC US Commodity Futures Trading Commission ECB European Central Bank EU European Union Fed U.S. Federal Reserve System IPO Initial Public Offering IMF International Monetary Fund ISDA International Swaps and Derivatives Association LBO Leveraged Buyout LIBOR London Interbank Offered Rate MBS Mortgage-Backed Security Nasdaq National Association of Securities Dealers Automated quotation NYSE New York Stock Exchange OTC Over the Counter SEC Securities and Exchange Commission SIFMA Securities Industry and Financial Markets Association WFE World Federation of Exchanges xi LIST OF FIGURES Fig. 1.1 Percentage of Large Moves in S&P 500 Attributable to Political Events, 1980–2015 5 Fig. 2.1 Silver content of Roman coins, 60–274 33 Fig. 2.2 Quantity of notes issued by Banque Royale, 1718–1720 37 Fig. 2.3 French assignats priced in gold livres, 1790–1796 40 Fig. 2.4 France cost of living index, 1790–1796 40 Fig. 3.1 Spanish imports of treasure versus price level, 1505–1650 48 Fig. 3.2 Number of democracies, 1871–1913 58 Fig. 3.3 US and UK retail prices, 1871–1913 58 Fig. 3.4 US and UK real GDP growth, with and without gold 60 Fig. 3.5 The global expansion of democracy, 1945–2014 66 Fig. 4.1 Bond market larger than equities, 2014 78 Fig. 4.2 Yield spread, Greece ten-year bonds versus German ten-year bunds, 2008–2015 83 Fig. 4.3 Selected yield spreads versus British consols, 1870–1913 85 Fig. 4.4 Total US household debt as % of GDP, 1952–2014 96 Fig. 4.5 G20 Advanced nations debt as % of GDP, 1880–2012 116 Fig. 5.1 Dow Jones Industrial Average 1900–2015 126 Fig. 5.2 Stock market capitalization as % of GDP, selected countries, 1988–2012 132 Fig. 5.3 Number of US IPOs, 1980–2014 161 Fig. 5.4 Ordinary investor performance versus Major Asset Classes, 1995–2014 164 Fig. 5.5 S&P 500 Index and quantitative easing, 2008–2015 175 Fig. 6.1 Usage frequency of “derivative security” in English Language Books, 1950–2000 179 xiii xiv LIST OF FIGURES Fig. 6.2 OTC versus exchange-traded derivatives, notional amount outstanding, 2014 180 Fig. 6.3 OTC derivatives market, notional amount outstanding, 1989–2014 181 Fig. 6.4 Absolute value of monthly changes in Moody’s Baa Corporate Bond Yields, 1950–2015 182 Fig. 6.5 Gold price of Greenbacks, 1862–1865 192 Fig. 6.6 Gold dollar price of Graybacks, 1861–1865 193 Fig. 6.7 Troy ounces of gold per 100 US dollars, 1971–2015 194 Fig. 6.8 Crude oil prices, 1950–2015 204 Fig. 6.9 Barrels of crude oil per troy ounce of gold, 1950–2015 205 Fig. 6.10 Payoff profi le of a covered call write strategy versus purchase of underlying asset 213 Fig. 6.11 CDS market by notional value, 2001–2014 219 Fig. 7.1 Ratio of FX trading volume to global trade, 1989–2013 229 Fig. 7.2 Euro/USD rate versus Big Mac Index, 2000–2015 236 Fig. 7.3 US dollar/Chinese Yuan rate, 2005–2015 254 LIST OF TABLES Table 5.1 Stock indices around the world 127 Table 5.2 Ten largest daily % changes, Dow Jones Industrial Average, 1928–2015 149 Table 5.3 US Fed response to bear markets, 1946–2009 173 Table 7.1 Key currency pairs 231 Table 7.2 Big Mac PPP implied rates versus actual currency rates, July 2015 235 Table 7.3 US dollar and presidential elections, 1976–2012 242 Table 7.4 US Dollar performance by presidential administration and party, 1977–2015 247 xv CHAPTER 1 Introduction: Why the Markets Must Be Politically Investigated “Democracy cannot be blackmailed”—so Alexis Tsipras, the Greek Prime Minister, declared triumphantly on the night of an extraordinary referendum. In a vote called just nine days before, the Greek public was asked to issue its verdict on the latest bailout proposal put forth by the country’s creditors. This group was owed the gargantuan sum of €323 billion, equivalent to 177 % of Greece’s GDP. On July 5, 2015, the Greeks voted against the bailout offer with a resounding NO, reject- ing it by a margin of 61 %–39 %. Leading up to the referendum, com- mentators widely depicted the vote as a climactic moment in a struggle pitting Greece’s left-wing government against Europe’s more orthodox political and economic establishment, with the fate of the euro currency hanging in the balance. Economic and fi nancial analysts drew the vote as a fi ght. On one corner of the ring was a small country desperate to end years of austerity, though still wanting to retain the euro; on the opposite corner was a larger set of countries, led by Germany, com- mitted to enforcing the fi scal requirements of a continental currency. Underlying the entire drama, however, was a more fundamental cross- ing of forces. Tsipras’ words alluded to it: the interplay of democracy and fi nancial markets. At the time of the referendum, this dynamic was obscured by the fact that the confrontation had taken on a predominantly political cast. Aligned against the Greek government were other state actors, the so- called troika made up of the European Commission (EC), the European Central Bank (ECB), and the International Monetary Fund (IMF). © The Author(s) 2017 1 G. Bragues, Money, Markets, and Democracy, DOI 10.1057/978-1-137-56940-0_1 2 G. BRAGUES These now held the bulk of the Greek debt, rather than private investors and commercial banks in the fi nancial markets. Yet back when Greece’s predicament fi rst came to a head in the spring of 2010, it was precisely those investors and banks that stood chiefl y exposed to the country’s debt in the form of Greek government bonds. With the euro then in free fall over concerns that Greece’s troubles were spilling over into Spain and Portugal, European Union (EU) leaders worked late into a Sunday night to come up with a rescue plan.