Why The Stock Markets Were Falling
The U.S. stock market - in fact many markets around the world - tanked this past week. Markets can be volatile. Sometimes it's better to ignore the volatility. It passes. But sometimes markets go beyond the usual volatility to state best described as "panic selling." I think we were seeing panic selling.
You'll see all sorts of explanations for this. The most common right now is the "PIGS." These are the countries of the European Union - Portugal, Italy, Greece and Spain (Get it? P-I-G-S...?) - that are in the worst financial condition. Their problems are supposedly what's causing the sell-off.
Someone said to me, "You mean all this is going on because of Greece?!!" Good point. Greece is part of the European Union, which has over 300 million people. Greece's whole population is only around 11 million - less than the City of New York. How could little Greece create such problems? Not only is little Greece rattling the European Union markets, it's rattling world markets. Something's not right.
What about the PIGS? Could it be that Portugal, Italy and Spain, added to Greece, are the cause? I don't think so. Even if you add their populations to Greece, you get around 130 million. When you compare them to the population of not only Europe, but the rest of the world (which is over 6 billion), again, it's not that big a number.
So what's going on?
I think it only starts with Greece's sovereign debt. Sovereign debt is bonds issued by a government. Apparently the bonds issued by Greece are on shaky ground. Investors in those bonds (institutions and individuals) now doubt that the Greek government will be able to pay the interest that the Greek government owes them. But that's just the start of the problem. Let's move on to the other PIGS.
It seems that investors also believe that Italy, Portugal and Spain will also have trouble paying the interest that's owed on the bonds they've issued. So the problem with the Greek government's bonds just highlighted the problems with these other counties' bonds.
But something's not sitting right here. The markets already knew what I've just described. People say that markets are "smart." If that's true, then markets should have already "priced in" the possiblity that there would be problems with these bonds. And if markets had already priced in the possibility, then why are markets rattled now? Why are prices falling?
One reason might be that it's not just the PIGS that may have problems. Indeed, some reports in the financial press mention the possiblity that if the PIGS "go" (if these governments begin to default on the payment of interest), this will somehow result UK bonds (Great Britain) getting into trouble next. Maybe we're getting close to understanding the panic. It could be a fear of a sort of "chain reaction." The question now is: does the chain reaction stop with the UK?
My best guess here is that if markets calm down and over the next few days strengthen, then investors will be thinking that the UK, even if it should come under pressure, will be the end of the chain. In other words, the worry and fear that the government of the UK will not be able to
pay interest on its bonds will be priced in to the market and that will be that.
Question: if markets are so smart - if the stock market really does discount the future - then why didn't they see this before? Why wasn't the possibility that the UK might not meet its interest payments already priced into the market. Did investors just discover this possibility?
More questions you might ask: Did the bail-out programs that so many governments pushed out over the last couple of years distract investors, even fool them into thinking that everything was OK? And are investors now having second thoughts?
We could go on with even more questions. But here's what I think we're seeing. I think we're seeing first of all how fragile our markets have become in the last few years. I also think we're seeing that the rattling of the markets was a signal. The markets have signaled that we may have an even bigger problem with sovereign debt throughout the world. It may not be restricted to just the the PIGS and the UK.
If things do remain calm for now, we may have seen the worst pass - at least for now. On the other hand, we may be seeing the first signs of a much more widespread problem with the sovereign bonds of a lot more countries. And if that's the case, then we can anticipate the stock market, and other markets to start falling again in the not too distant future.
Then again, it might be good to remember this: prior to World War I, the bond market was relatively calm and stable only a few months before war broke out in August 1914. In spite of the build-up of military forces and the growing tension in the air, everyone, including apparently much of the "smart money," simply thought cooler heads would prevail.
You'll see all sorts of explanations for this. The most common right now is the "PIGS." These are the countries of the European Union - Portugal, Italy, Greece and Spain (Get it? P-I-G-S...?) - that are in the worst financial condition. Their problems are supposedly what's causing the sell-off.
Someone said to me, "You mean all this is going on because of Greece?!!" Good point. Greece is part of the European Union, which has over 300 million people. Greece's whole population is only around 11 million - less than the City of New York. How could little Greece create such problems? Not only is little Greece rattling the European Union markets, it's rattling world markets. Something's not right.
What about the PIGS? Could it be that Portugal, Italy and Spain, added to Greece, are the cause? I don't think so. Even if you add their populations to Greece, you get around 130 million. When you compare them to the population of not only Europe, but the rest of the world (which is over 6 billion), again, it's not that big a number.
So what's going on?
I think it only starts with Greece's sovereign debt. Sovereign debt is bonds issued by a government. Apparently the bonds issued by Greece are on shaky ground. Investors in those bonds (institutions and individuals) now doubt that the Greek government will be able to pay the interest that the Greek government owes them. But that's just the start of the problem. Let's move on to the other PIGS.
It seems that investors also believe that Italy, Portugal and Spain will also have trouble paying the interest that's owed on the bonds they've issued. So the problem with the Greek government's bonds just highlighted the problems with these other counties' bonds.
But something's not sitting right here. The markets already knew what I've just described. People say that markets are "smart." If that's true, then markets should have already "priced in" the possiblity that there would be problems with these bonds. And if markets had already priced in the possibility, then why are markets rattled now? Why are prices falling?
One reason might be that it's not just the PIGS that may have problems. Indeed, some reports in the financial press mention the possiblity that if the PIGS "go" (if these governments begin to default on the payment of interest), this will somehow result UK bonds (Great Britain) getting into trouble next. Maybe we're getting close to understanding the panic. It could be a fear of a sort of "chain reaction." The question now is: does the chain reaction stop with the UK?
My best guess here is that if markets calm down and over the next few days strengthen, then investors will be thinking that the UK, even if it should come under pressure, will be the end of the chain. In other words, the worry and fear that the government of the UK will not be able to
pay interest on its bonds will be priced in to the market and that will be that.
Question: if markets are so smart - if the stock market really does discount the future - then why didn't they see this before? Why wasn't the possibility that the UK might not meet its interest payments already priced into the market. Did investors just discover this possibility?
More questions you might ask: Did the bail-out programs that so many governments pushed out over the last couple of years distract investors, even fool them into thinking that everything was OK? And are investors now having second thoughts?
We could go on with even more questions. But here's what I think we're seeing. I think we're seeing first of all how fragile our markets have become in the last few years. I also think we're seeing that the rattling of the markets was a signal. The markets have signaled that we may have an even bigger problem with sovereign debt throughout the world. It may not be restricted to just the the PIGS and the UK.
If things do remain calm for now, we may have seen the worst pass - at least for now. On the other hand, we may be seeing the first signs of a much more widespread problem with the sovereign bonds of a lot more countries. And if that's the case, then we can anticipate the stock market, and other markets to start falling again in the not too distant future.
Then again, it might be good to remember this: prior to World War I, the bond market was relatively calm and stable only a few months before war broke out in August 1914. In spite of the build-up of military forces and the growing tension in the air, everyone, including apparently much of the "smart money," simply thought cooler heads would prevail.
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