Pot of boiling frogs

Global stock market volatility within a defined trading range has been the name of the game for quite some time now. As the market whipsawed investors through the euphoria of stunning market rallies and the despair of precipitous market declines, I often suggest that it is possible for one to go away on vacation turn of the computer and when they return, it would seem as though nothing has happened. This is exactly what has happened during my time away. On October 26, the United States stock market as measured by the S&P 500 stood at 1,242. As at last Friday’s the market closed at 1,244. In between those two periods, you had a strong market sell off followed by last week’s performance, which resulted in the biggest weekly percentage gain since March 2009—this being the month when the market started to rebound from the lows following the credit crisis in the US.

Volatile movements within a range bound market may be disconcerting, but because the market has no definite trend of either a rally or a decline, it leaves many oblivious to the real issues that the global economy and, by extension, the T&T economy faces. Policymakers seem bent on trying to maintain the status quo at all costs for to do otherwise risks a political backlash. We have convinced ourselves that the problems that we face are cyclical as this provides a natural level of comfort. A problem that is cyclical will eventually solve itself as the cycle moves on. The solution is, therefore, a function of time. Wait long enough and the housing market in the US will recover, CL Financial’s asset values will rebound, oil and gas prices will go back up and because of time, we will all live happily ever after. All policymakers have to do in the interim is to keep making promises to appease the population until that day comes when the cyclical solution comes about.  While waiting, any situation that threatens to push things too far in one direction will be suppressed, even if it means that the existing crisis drags on without a definite solution. 

Black swans

Last month Nassim Taleb, author of The Black Swan, visited T&T. Back in June of this year, he co-authored the following: “Complex systems that have artificially suppressed volatility tend to become extremely fragile, while at the same time exhibiting no visible risks. In fact, they tend to be too calm and exhibit minimal variability as silent risks accumulate beneath the surface. “Although the stated intention of political leaders and economic policymakers is to stabilise the system by inhibiting fluctuations, the result tends to be the opposite. These artificially constrained systems become prone to “black swans”: that is, they become extremely vulnerable to large-scale events that lie far from the statistical norm and were largely unpredictable to a given set of observers.” From the public’s vantage point, the situation is analogous to what is often termed, The Boiling Frog Syndrome. According to the storyline, place a frog in a pot of boiling water and it will immediately feel the heat and jump out. However, place the frog in a pot of cold water and the frog will sit comfortably. If the heat is gradually turned up, the frog will be oblivious to the changing temperature and, eventually, as the water is brought to boil, the frog, unaware of the changed surrounding, will be boiled alive.

The point is that as while we bask in the illusion of a stable environment with minimal variability, we are unable to fathom the consequences of real and even suppressed changes and, so are not able to properly react to what is happening. If and when we do become aware, it will be too late. A couple weeks ago, a Government bond auction for one of the leading economies of the world, Germany, failed to attract the necessary demand. In T&T, worn out as we are by two years of talk of a Euro crisis, we are oblivious to the fact that major economies around the world are having difficulties in obtaining financing. This at a time when T&T and the wider Caribbean are increasingly reliant on debt financing, not least of which is to pay Clico policyholders. 

Last week we saw co-ordinated global central bank action not seen since the collapse of Lehman Brothers. The underlying reason was to support European banks, where, as I have pointed out many times here, silent bank runs are taking place and the system is coming under increasing levels of distress. Despite the interconnectedness of the global economy, none of these issues seem to matter to us in T&T. Instead, we seem to be preoccupied with the political wrangling of conspiracy or no conspiracy and the trite gossip as to who was making how much within the CL Financial Group. The substantive issues and the impact on the national situation are far removed from the discussion and, so we sit as a nation of frogs in a pot while the water is slowly brought to boil, while policymakers desperately try to maintain the façade of business as usual.

Flawed approach

In terms of the alleged security threat to the nation, the Government has taken an approach which can best be described by borrowing a term from the world of physics. Counter-factual definiteness is, in layman’s terms, the inference of an outcome without performing an experiment to substantiate the result. If you throw a ball in the air, gravity is going to bring it back down. We know this from past experience and so can make the claim without actually throwing the ball in the air. Similarly, piece together activist members of the Muslim community and a cache of arms and ammunition and just as in 1990, we have a “treasonous plot.” The problem is that if you throw up a ball in a strong breeze, it may not come down as it always does, but may be blown away. Without performing the experiment to gather the evidence, you will not know the outcome. This is what those opposed to the Government are seeking and so the debate continues.

While that is taking place the real issues are shunted aside. There are reports of $1.5 billion in drugs being seized, a multi-billion diesel racket has supposedly been busted and, hopefully, much more in the future. Recognise that these dollars formed part of the local economy and their removal leaves a gap that must be filled by legitimate business activity. The only problem is that the manner in which the Government and Opposition have gone about their business only provides incentives for those in the country with legitimately acquired wealth to seek to take those funds outside the country, as opposed to utilising those resources for our economic development. So the water boils while the frogs sit. We are approaching three years since the collapse of CL Financial and the passage of time has brought a cyclical solution to what is essentially a structural problem. People are finally getting paid and all is now well. Except that there is a group that still wants to have it all and a country that remains uniformed as to what happened, why, and what exactly is the present circumstances and the plan for the future.

We are oblivious to the fact that we have taken a private sector liability and transferred it onto the State balance sheet. Now with the payout, we are transferring interest rate risk back to the private sector. Space does not permit a detailed explanation, but zero coupon bonds, such as those being issued to executive flexible premium annuity (EFPA) investors and being bought by financial companies, are more sensitive to changes in interest rates. If interest rates rises by one per cent, the value of a typical ten-year bond will fall by 7.8 per cent, while the value of a ten-year zero coupon bond will fall by 9.9 per cent. With almost $5 billion of zero coupon bonds ranging from one to ten years being bought by financial institutions from EFPA policyholders, the financial system as a whole will become more sensitive to changes in interest rates and will be adversely affected if interest rates were to rise sharply. We have tried to make the fall out from the CL Financial debacle as painless as possible in the hope that it will all work itself out. Maybe it will, but are we accumulating other silent risks in the process. Please take a moment to reread the above quote from Nassim Taleb. Is it my imagination or is this water getter warmer?  

Ian Narine is a broker registered with the Securities and Exchange Commission