Let's twist again

We sang it at work on Thursday morning. As most analysts anticipated, The Federal Reserve did not decide to launch QE3. We have already had two round of quantitative easing programmes, consisting in buying government bonds by the central bank to boost liquidity in the financial system. This operation boils down to printing money (in civilised countries it is illegal, so maybe the United States no longer deserve being called "civilised"). The first two rounds carried out between late 2008 and early 2011 resulted in nothing more than bull market on stock and commodity markets. The beneficiaries of the programmes were speculators, so again, Wall Street was better off, Main Street had to stay in the doldrums.

Funnily enough, the old adage that you should not play against the Fed proved true again. Okay, buying up lots of government bonds from the banks gave them a lot of free money that had to be utilised somehow, so cash created extra demand on financial markets But hang on. Was it not the mechanism of self-fulfilling prophecy that worked again? If everyone believed stock prices would go up if the Fed began to print money, would eveyone not buy stocks which would be about to go up in prices?

Unfortunately for some of the speculators, the Fed has run out of space for another operation, as inflationary pressures began to heighten and more and more members of the governing committee were against the easing. The alternative plan will now be followed out - the US central bank will be determined to change the shape of yield curve, to be precise to flatten it. To follow out this plan, Mr Bernanke will order to sell short-term bonds and from proceeds he will buy long-term bonds. This should help the economy revive and is mostly aimed at kick-starting the housing market, as interests on mortgage loans are benchmarked to long-term interest rates. Time will tell if the real economy benefits from this operation, probably the action was arranged in collaboration with the government which will find it easier to sell its long-term bonds and thus the Fed will put back the moment when the United States default, which is just a matter of time. Of course they may not default, but only thanks to high inflation which would reduce the real value of US public debt.

Markets' reaction was more or less predictable and more or less apposite. Scatts, sick of hearing about stock swinging up and down ranted about "moronic stock markets". His piece is an excellent observation from a down-to-earth participant, yet not an economist and not someone who has an in-depth insight into the psychology of usually irrational market participants. In a comment I promised to refer to some of his points.

Scatts goes on about higher volatility. It has become the order of the day that one day stocks soar, the other plunge, sometimes there are a few days in a row when prices move in one direction, than the tide turns abruptly. Firstly, it proves we are in a bear market. It is not only the trend that tells you if a market goes up or down, it is also the volatility. The more nervous market participants are, the more likely it is 'bears' prevail.

But in such days volatility can be a friend. If you are a long-term investor, skip this paragraph... My prescription for successful trading when the markets are wobbly is to swim against the tide. If stocks skyrocket, I sell, if they plumment, I buy. The other part of my strategy is not buying and selling in one chunk but splitting orders into tranches and placing them and different prices. The goal is to lower as much as possible the average purchase price. The task is not easy, requires patience and intuition and brings out some adrenaline...

Communication - markets today buy and sell rumours, declarations, reckless pronouncements, unfounded theories. One politician says there is a plan to stave off Greek default - stocks go up. One economist says bankrupcty of Greece is inexorable and the sooner - the better - stocks go down. Someone says a French bank has troubles borrowing money on inter-bank markets - shares of that bank nosedive... On and on... Markets, if they acted more rationally, would respond to facts.

And facts are that nothing is going to save Greece, economies in Europe and across the world are slowing down, banks will need to write down Greek bonds. I cannot see any point in putting this hapless moment back. Let it happen, ride out the tsunami, what is brittle has to fall down before it grows too big (it has already grown, too late), economies need to be healed from all imperfections that cuased the crisis. Putting some countries and instututions out of misery would make the best way. But most people want to avoid chaos, maybe cherishing stability is a commendable strategy, but at all cost?

Just like in late 2008 and early 2009 Polish currency was recently hit by speculators. Short-sellers are throwing more and more PLN on the market and zloty has depreciated notably in September, by roughly 15% against EUR and USD. Last Friday the Polish central bank and state-owned BGK sold some foreign currencies to prop up PLN. They managed to bring down EUR/PLN and USD/PLN by some 0.10 PLN within half and hour. But is any central bank capable of fighting speculators trying to decrease the value of a specific currency? Of course buying PLN in bulk can activate some stop-loss orders and deter some speculators, but only in the short run. I would sooner desist from any actions. After all Polish companies are not hit by toxic currency option as they were in early 2009. Weaker PLN will boost our exports and competitiveness and increase Poland's chance to get off the second wave of the crisis lightly.

The main condition we have to fulfil to avert dire consequences of the second wave of crisis is wise management of our public finances, as private sector appears to be prepared quite well for a slowdown. And here reality fills me with dread for two reasons...
In two weeks the parliament election will be held. I do not dare to predict who wins it, but...
PiS, currently in the opposition wants to bring public finances into order, but at the same time promises the moon. Its declarations are self-contradictory - you cannot have a cake and eat it, you cannot give something to somebody without taking something away from someone else, you cannot increase budget expenditures anc cut budget deficit... It is not said in their agenda how they are going to raise money for all the giveaways...
PO, currently in power rather leans towards realpolitik and holds back from making big promises, but on the other hand the PO-led government has inclination for tweaking with figures, so they will bend over backwards to avoid exceeding the 55% public debt / GDP threshold (possible, if EUR/PLN rises on 31 December 2011 to some 4.70), which would force the government to pass a balance budget for 2012. That would not be possible without painful retrenchment and tax hikes, yet this scenatio is much better than sweeping the problem under the carpet and lifting the threshold and consequent obligations to curb deficit and implement turn-around plans. I hope no matter who wins the election, the people in power will be judicious. I know, Poles deserve more, but more important is what Poles can afford than what Poles deserve. And if we do not want to end up like Greece, we should be guided be the former.