August 15, 2011
This week is the 50th anniversary of the building of the Berlin Wall.
As a student, in the summer of 1989 just before the whole system imploded, I walked with a few others through Checkpoint Charlie into the twilight zone of East Germany to catch a train from East Berlin’s main train station to Prague.
The train itself was operated by East Germany’s railway company -the anachronistic and un-communist sounding Deutsche Reichsbahn.
The ancient rolling stock travelled from Berlin on a magical mystery tour of Soviet Bloc capitals ending in Bucharest, passing through Czechoslovakia, Hungary, Yugoslavia, Bulgaria and on to Romania.
The carriages were divided by nationality with the German guards looking down their noses at the Slavs, particularly, for some reason, the Bulgarians.
We hopped onto the German section and settled into the wooden seats for a rattly journey which took us towards the still bombed-out centre of Dresden. Beyond Dresden, the train line followed the beautiful Elbe river through some of the most spectacular countryside in Europe.
Even though there was a lot of talk about East Germans seeking refuge in the West German embassy in Budapest, there was no sense that the whole communist system would fall apart.
This was only three months before the Berlin Wall was torn down, yet as is the way when big systems collapse, no one can get their heads around what might happen. No one is prepared to think the unthinkable.
Within months the game was over. These formerly closed countries opened up to the market. Initially, stock markets opened, as did currency markets.
Then, after massive debt forgiveness, the bond markets of a huge landmass from Berlin to Vladivostock opened up and the lives of hundreds of millions were changed irrevocably.
For financial markets, this geo-political shift was an extraordinary opportunity. Anyone with a passing knowledge of this part of the world was suddenly an ‘expert’ in what became known as ‘emerging markets’ finance.
A few years later, probably as a result of an interest in this part of the world, particularly Russia, I found myself on what is called a ‘proprietary trading desk’ in London at a large investment bank in the City.
Our job was to make money for the bank by speculating on the bond markets of the former Eastern Bloc.
At the time, this was regarded as ‘frontier’ finance because these places were considered slightly risky, yet certain banks were prepared to risk their shareholders’ capital in places where the boards of the banks had never been.
All they cared about was that we seemed to be making lots of money, and they looked smart.
One of the big changes in finance since those days is that, today, much of the world and certainly peripheral Europe look like emerging markets. Ireland is a classic case in point, depending on foreign capital to finance itself and its banks.
We have opened ourselves up to the financial casino.
Now the financial casino is out of control, with the policy of countries being judged by people who have no idea about the countries. So during last week it was ‘sell France’, the previous week it was ‘sell Italy’.
Who will be attacked this week?
This casino and the interests of speculative funds are now – as they were in East Europe back then – being put before the interests of the citizens.
Anyone who questions this nonsense is denigrated as not understanding the markets and not grasping how smart, wise and forward-thinking the markets really are.
In reality, what actually happened on proprietary trading desks – which are hedge funds within banks – was not that smart at all.
In my own case, the bank gave a small team of five individuals lots of money to play with.
The key assets were bonds issued by Russia. At the time in the mid-1990s,Russiawas borrowing from the west for the first time since the October Revolution.
As is usual on ‘prop trading’ desks nothing much happens until a big figure is reported and the market moves according to whether the figure is actually stronger or weaker than what the consensus expected it to be.
One of the biggest figures was what is called the US ‘non-farm payroll’ data, which comes out every month. The non farm payroll measures how many jobs are created in the US economy.
To see what happens, let’s take the example of a particular month where the consensus view in the financial markets was that there would be 250,000 jobs created in the US.
Imagine that ‘only’ 160,000 jobs were actually created. The bond market would rally on this news because a weaker economy (as indicated by weaker jobs data) would mean that interest rates were likely to be cut.
The bond market reacts positively to bad news. I realise that this sounds counterintuitive, but it isn’t. If interest rates fall, the price of bonds rise.
So now think about a ‘prop’ trading desk with a few traders and an economist who are supposed to be assessing risk in Russia, yet they are looking at the non farm payroll of the US.
All the while, Russia itself is being robbed by the oligarchs under the bleary eyes of a permanently tipsy Boris Yeltsin.
So they were borrowing and robbing at the same time, destroying wealth today and lumbering their children with debts tomorrow.
Yet this hardly mattered to the performance of the Russian market; what mattered was sentiment towards the US bond market.
Think about it: here we have the immediate economic prospects of a superpower, Russia, that only five years before was challenging the US, being reduced to the mood of speculators in prop trading desks and hedge funds.
My job was to figure out, using an array Of other economic data from the US, whether the consensus was a bit too optimistic or a bit too pessimistic. If I thought the figure was to optimistic, based on my own analysis, we would bet on Russian bonds and take big option positions to allow us to buy Russian debt at today’s price some time in the next few months.
If the non-farm payroll figure actually was worse than the consensus was expecting, the market would rally and the prices of all bond markets around the world, particularly those in the emerging markets would rally and we would make money.
That’s it. Sure there were rules about how much could be gambled.
There was a back office clearing all the trades, but in essence, the traders ruled the roost. Things haven’t changed much, except for the fact that these speculators have multiplied into thousands of hedge funds and the amount of money they are playing with has increased exponentially.
This is the so-called financial market.
If we fast-forward to today, we see that these trading desks are still the backbone of investment banking, while hedge funds dominate the trading environment. In addition to strategists and economists, there are algorithms and charts, which are used as trading strategies, signalling all sorts of buy and sell trigger points.
And as the world has become more economically unbalanced, with huge individual creditor nations and many smaller debtor nations, the basic emerging market model of the world applies not to former communist countries, but to most other countries.
The attitudes and greed of traders in the markets are leading to chaos.
This is why they need to be controlled and policed; otherwise we are in a situation where these guys will boss around governments and their lackeys in the rating agencies – who got everything wrong in the past few years. And they will become more powerful than elected politicians.
The markets aren’t clever or smart; I know because I have worked in them. I have seen good companies along the old East European train route dismantled by people who knew nothing about the specific industry and sold off to people who knew even less.
I have seen credible countries dragged into the mire just because some trader on a losing streak has to sell a performing asset to cover the losses on his falling assets. This rapacious form of capitalism only benefits a tiny handful of people. It makes the world unstable and puts countries on collision courses with each other, which European history suggests, can lead to something much worse.
If you don’t want to believe that, just take a train journey through central Europe and consider what actually happened there.