The Road to Financial Serfdom

We are on a road to financial market serfdom. Hayek wrote forcefully on the slide to socialism and the loss of individual freedoms which occurs when government takes on greater roles in the lives of citizens. There is a new analogy with government creep into determining prices of asset markets. This shouldn’t be surprising with the growing importance of asset flows and finance relative to fifty years ago. Unfortunately, there has arisen a forceful advocate for the dangers of government intervention in managing assets.

Thanks to a friend who sent the piece “Russia: The newest member of the SWF club” from Morgan Stanley’s April 27 FX Briefing Note by Stephen L Jen, and spurred me to think on this issue. SWF stands for the Sovereign Wealth Fund. The club represents those countries that have moved their reserves into actively managed risky assets.

The active role of government in trading is moving beyond just the traditional role of price stabilization. It may now be attempting to generate profits for the good of their citizens. This is being done directly or through hiring outside managers but is intended to maximize returns and not just meet simple welfare objectives. This activity can place significant price pressure on markets through their tremendous buying power. Innocents may say that this is no different than a large pension fund. Unfortunately the opportunity for misuse is large especially at times of financial stress. The actual behavior of SWF club members may differ from what may occur if there was a different end client. Market power may lead to new price stabilization policies which are not based on macro policy goals. While we are not trying to conduct a historical analysis, the trends of governments engaged in active trading are compelling:

Oil production is now controlled by a national oil companies who have reserves that exceed those of private companies. The renationalization of Russian and Venezuelan oil are just two examples. The purchase of oil reserves by China is another example of sovereigns indirectly trying to control supply. While stabilization policies of Saudi Arabia may have provided resistance toward rising prices, these same policies may interfere with prices seeing significant declines.

Active management of foreign exchange reserves by some European countries and now Asian central banks is growing. The information on the activities of these central banks is limited. In the case of balance of payment surplus countries, monetary policies have not been used to help mitigate the growth of these reserves or allow for an orderly appreciation.

Strategic purchase and sales of metals has increased with the increases in prices. Arguing for nationalization and better deals with mining companies has increased in the last two years. National companies have also become more active in the upstream marketing and hedging of these commodities.

Agricultural subsidies continue for the major grain markets through direct payments, boards for exports, loan programs, and now subsidies for ethanol production. What would the price of corn be if there were no government subsides for ethanol plant production? What would be the price of corn or ethanol if import tariffs on foreign sugar and ethanol were lifted?

Debt buybacks and switches by governments to manage debt structure have increased. The debt switches to lower financing costs will come at the expense of current bondholders.

Limits and coordination on the sale of gold reserves by central banks to maximize the price received was actively use when gold was at lower price levels.

Monetary policy, while not focused on fixing interest rates, targets inflation and thus nominal short-term interest rates. These policies can affect the supply of inflation protected bonds.

Talk of capital controls which attempt to slow the speed of adjustment of asset prices by foreign buyers is on the rise after a long period of free capital flows.

Discussions of blocking cross-border mergers and acquisitions which are not believed to be in a nation’s interest have also increased with the explosion of non-US M&A activity.

Certainly, we have come a long way from fixed exchange rates, controlled interest rates, and vigorous capital controls, but there is a growing argument that we have seen the zenith of asset market freedom.