Rational Markets?

The general impact of the French riots is, I feel, being ably covered by others here, what I am curious about is how financial markets reach their opinions. According to headlines in many newspapers, the euro is falling aginst the dollar as a result of what is happening in France (or see here). This may or may not be a good reading of why the euro is dropping, but if it was the explanation, I would say it was a far from rational response.

Maybe a useful starting point here would be the latest post from Brad Setser on the recent highs of the renminbi (and dollar) vis-a-vis the euro. Brad, who has long been of the opinion that the continuing US current account deficit must be dollar negative mid- to long-term, finds himself understandably rather frustrated. As he points out it seems Morgan Stanley currency theorist Stephen Jen may have been right: the US CA deficit isn’t the driving force in the currency markets at the moment, growth and interest rate differentials are. (More humbly I have also been arguing in favour of this view).

So what some may on occcasion refer to as ‘the fundamentals’ are in fact the driving force behind the euro fall, and indeed yesterday’s call by the eurozone finance ministers against any early raising of interest rates at the ECB may have as much to do with market responses as anything that is happening in France.

So why don’t I think it would be rational to go Euro negative based on the French riots. Well, if what you’re into is a panic reaction, then maybe you could read things that way, but if you really start to analyse, and ask the question what happens next, it’s hard to come to the conclusion that this is going to damage the reform process in France. In fact quite the contrary may well be the case. Basically my feeling is that the French government will by now have finally realised that there is a high on-cost (and a high risk of unpleasant consequences) attached to having an unemployment level of around 10% as an ongoing state of affairs. The consequence is that they will now in all probability be much more focused when they address labour market reform issues: ie there is likely to be more reform not less (remember that those who are rioting are outsiders, and hence unlikely to be resisting the kinds of changes envisaged in the reforms, especially if these changes give more stability to youth employment in exchange for weakening the position of long-term employment ‘stakeholders). Part of the explanation for all this rage must surely be found in the fact that those who find themselves outside now want to come into the tent. I mean, it is hardly credible that French policymakers are simply going to sit back and risk letting a bunch of disgruntled adolescents do what they didn’t let the Germany army do in 1945: ie burn-down Paris. Equally, it looks like the reform-minded Sarkozy will emerge from all this with his hand strengthened. And what we can expect to see from Sarkozy is a mixture of firmness with flexibility. The rioters ‘no passaran’ (as one blog entitles itself), but after they haven’t ‘passed’ you can expect to see a lot of far reaching and significant changes.

So if the markets were really rational they would be pricing-in a new reform impetus in France and this should (in theory) be pretty euro positive.If you really wanted to stick your neck out and defend going euro-negative simply on the French impact, then probably you would need to do this via the short-term impact on interest rates, since the French administration will certainly be in no mood to countenance ‘hawkish monetary experiments’ just now.

Nero, it is true, fiddled around while Rome burned, but you have to be extremely naieve to think that the EU commission is similarly going to sit back and watch while Europe does. Methinks the wind of reform is really about to start to blow.

Incidentally, and purely coincidentally, New Economist has a link to a paper (via Mark Thoma) from MIT based French Economist Olivier Blanchard. The issue behind the paper: “European Unemployment: The Evolution of Facts and Ideas

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About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

8 thoughts on “Rational Markets?

  1. there is likely to be more reform not less

    “We are decreasing your job security because the muslims in the suburbs are rebelling”
    You do not want to say anything remotely close to that. Or even anything that with evil intentions could be misconstrued as saying that. You might just as well simply see more money thrown at the suburbs.

  2. “You do not want to say anything remotely close to that.”

    The thing, Oliver, in politics is often not so much what you say, but what you actually do. But this isn’t the fundamental argument for labour market reform, it’s just one additional element.

  3. I am afraid, politics is based on being elected (in France at least). You are elected based on impressions not on facts. Labor market reform may be sensible, but it is surely unpopular.
    Furthermore, how many of the proteters can be considered employable in a reasonable time frame? What is their level of education? In many cases I fear it to be unacceptably low.

  4. Maybe newspapers are prone to pick the noisiest event of the recent past, that is still likely to be on readers minds, as an explanation for any eur/$ movements. At moment the squabling would-be coalition government of the other big eurozone economy doesn’t seem confidence-inspiring either and would also serve as a good candidate to blame for the currency movement. And probably they would have taken that as an explanation if it weren’t for the aesthetics of burning cars.

    Apart from that, I wonder if these riots will have any lasting impact on immigration policy.

  5. “I wonder if these riots will have any lasting impact on immigration policy.”

    I think here you are touching on something important: I imagine they might well have an impact.

  6. The dollar is firming because of higher interest rates which attract, or at least defuse selling in US treasuries. A right wing crack down against the rioters would probably give the Euro a lift. Do they have Fox news in France?

  7. Hmm, how about legalizing cannabis use and trade so that the “unemployed” and negatively judged can turn “employed” and positively viewed innovators? Not to mention change of relationship with police (which arrests lots of these people on cannabis related charges). Aren’t economists supposed to remind the public about this affair? 🙂

  8. Ironic that all this takes place only a few days away from an EU informal summit that was intended to discuss EU social “models”. The riots kind of cut the ground away from under the feet of the French, who are irredemably snooty about the fact that “their” social model does not undermine social cohesion the way the “anglo-saxon” model does. I have to admit to a little schadenfreude.

    But I’m not sure I share Edward’s view that this will galvanise economic reform at EU level. The CAP is not going to disappear. The problems with the Bolkestein directive and other sensitive topics will remain. The Commission has already put the Lisbon ball in the court of the member states and they resolutely refuse to hit it. And we may even suceed in totally derailing Doha on the back of a policy that has been out of date for 30 years (the CAP – again). Plus ca change….

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