Arbitraging markets and politics

October 3, 2010

Today I had a fascinating conversation with someone from the City. Not simply “someone” — but let’s leave it at that. Point is, our talk confirmed the potential of a sociological lens for understanding (and exploiting) the post-crisis financial context.

The chat centered on a key change in finance. Forget stocks. Forget bonds. The big bucks are now to be made in foreign exchange. The two-digit returns lie in predicting, say, the future appreciation of the dollar versus the euro.

From markets to politics

Far from being a technical twist, this change reflects an important sociological development in the post-crisis environment: the continuous blurring of markets and politics. That money and votes go together is almost a cliché. But exactly how – that is more complicated. And indeed, sociologists have fought over this again and again. At the 2009 “Politics of Markets” workshop, Neil Fligstein and a bunch of European sociologists (myself, and my co-organizers Marion Fourcade, Fabrizio Ferraro and Yuval Millo) debated the mechanism for an entire day. Is it through the design of market devices, as Michel Callon would have it? Or is it by influencing institutions, as Fligstein favors?

Current events speak to that. “Events,” my financial acquaintance said, “are unfolding exactly as expected – just like in the script of a film.” Ireland is spending more and more to bail out its banks, Portugal is in trouble. Spain and Greece are not better. The US and England — printing money like there is no tomorrow, their currencies are under stress. And all of it could have been predicted. Six months ago. By simply looking at the sum of their private and public debt.

Debt, as it turns out, has turned an economic crisis into a political one. The banks of all of these countries ran reckless strategies that landed them with tons of toxic assets. They should all have gone broke, but due to political constraints they did not. Private debt became national debt, and to the tune of more money than what many countries can handle. At a stroke, then, an economic problem became a political one. Thus, Act I of the crisis entailed private banks. And Act II — the predictable script that my friend referred to — entails public finances.

Although predictable, the response has been diverse across countries. Those with low debt levels – Switzerland, Australia, Canada– can simply take on some more. The US and the UK can print money. But the countries in the Euro-zone like Ireland, Portugal, Greece, Spain (yes, there’s an animal hidden in these initials) cannot fiddle with their rates. They are bound by the rules of macroeconomics.

Arbitrage opportunities

This opens the door to arbitrage opportunities of the kind discussed by Stark and I in “How To Recognize Opportunities“. Grappling with them takes a sociological appreciation for the blurry space of markets and politics. This is difficult for traders, because they are used to the logic of the market, and to business as usual. The key here is to predict market outcomes based on expectations of what the political actors will do or not. And of crisis – change, inflection point, new rules of the game.

And indeed, this is the scenario where George Soros made his fortune, forcing the British pound outside the maligned European currency unit. As recounted by Soros himself, his private conversations with the German central bank at the time convinced him that Germany would not bail the UK out. And they did not. The equally famous trade by John Paulson against the credit bubble also straddled markets and politics.

A Soros trade in the post-crisis environment

How to pull a Soros/ Paulson trade in 2010? At some point, Mr. Someone explained, one of these countries will go bankrupt. What will the European Central Bank (read: “the Germans”) do then? Print money and hand it over to the suntanned southerners? Kick the spendthrift out of the Euro? Leave the Euro and sail away solo? Politics are intimately bound with the market in this context. And the tree has other branches. Say, the Chinese could worsen the global imbalances by escalating its export-led growth model. Or the US could admit that it’s debt is worth less than half its nominal value. In all cases, the key to these decision branches is that the choice entails a political logic in an economic context.

There’s another aspect. The doom scenario is so bleak, according to my contact, that investors are not even thinking about it. Too ugly. Fixed income pension funds are holding in cash all their new revenues. They’re supposed to hold bonds – that’s the point of being a “fixed income” fund. But they know they could lose their shirts. Yet they are not selling any of their vast existing bond holdings either. So they’re not acting as they normally would, but they’re not following their fears to their logical extreme, which would be to abandon their own social type, liquidate, and get the hell out. The decoupling, in other words, is there for any sociologist to read.

After a long and intense discussion, Mr. Someone and I looked at the clock. Eight pm. Time to move on. As I walked back to my home in Clerkenwell (East Central London), I was struck by how luck I am to be a sociologist of finance in a city like mine. Stuff happens. And sometimes, with a bit of luck, I get to see it coming.

12 Responses to “Arbitraging markets and politics”

  1. yuvalmillo Says:

    Daniel, thanks for this. I really like this sort of eye witness (or ear witness) accounts. I completely agree that if we (both academics and practitioners) want to have a better understanding of markets then we need to analyse different logics of operation (or, different orders of worth), as market actors operate, simultaneously, in more than. I think however, that you, or your friend, disregard the deep political understanding that many market practitioners show, especially the ones dealing in FX. Apologies for the shameless plug, but, thinking about it, I have a nice example showing how market actors mix and match the different discursive realms when trying to make sense of the market: see the example in pages 17-18 (
    Putting all this aside, I would really like to hear more about decoupling and pension funds: what do you mean there, exactly?

  2. danielbeunza Says:

    Thanks Yuval. I see your point but disagree. What you have in your paper (which I very much appreciate, as you know) is an example of how hedge fund traders are including political factors into their trade. But the trade that they are doing is the usual one — in this case, merger arbitrage.

    What I am talking about is different — how to confront a change in the rules of the game, especially when this game is shaped by politics?

    In the current case (according to Mr. Someone), one new security that illustrates this problem is the purchase of Euro-denominated CDS on European banks. Investors have realized it does not make any sense. If Deutsche Bank goes down, the Euro is gone too. So buying protection against that in Euros is a bad idea. This has given rise to a new security, CDSs on European banks, but denominated in non-European currencies.

  3. joseossandon Says:

    Hi Daniel. Don’t you think that this is not just a matter of how finance studies (aka STS) should mix with institutionalist economic sociology, but perhaps, with the large scholarship about money? I am far to be an expert about this but my impression is that people like your LSE colleague Nigel Dodd or anthropologist Keith Hart had been thinking for long time about the political/economical nature of money. In this sense, perhaps finance studies should look for different kinds of theoretical help depending on the specific good traded in each case. Best, José! (here 2 examples:;

  4. danielbeunza Says:

    Jose — sounds interesting but I have not read them. Is there any specific point that these to articles make in relation to the post?

  5. joseossandon Says:

    I cannot re-read them now neither. But my point is simply: money is a very special “market thing”, it is always political and economical (following Hart: head and tail, number and state and so on), not just “institutionally” embedded or deviced, and, there is a very rich available discussion about this. Then, i suggest that in order to say something new about your case, might be useful to read these people. Best, J.

  6. Keith Hart Says:

    I recall driving across the Indiana plains in a thunderstorm, while listening to the radio news. The first item was about a rebellion in the Philippines which had reduced the supply of rice, the second about a struggle betwen the government and Southern land barons affecting the price of wwheat in Egypt. It went on and I realised that these Mid-western farmers must be among the most politically sophicated audiences in the world.

    We all know that ruling classes don’t alays mean what they say, but the bourgeoisie may be the only class in history to practice the opposite of what it preaches: markets without politics, impersonal rationality. Just look at the interests involved in formation of the Bank of England, the Banque de France and the Federal Reserve. Politicians need money and money men need poltiical cover. It is a pity that social science mainly reproduces the official ideology.

    I live in Paris, have a home in South Africa, my wife has one in Switzerland, my pension comes from Britain and I have a pesnion fund in the US. Becoming a part-time currency trader is a necessity for me, not to make a killing, but to hedge against loss of assets and income.

    It might be more useful to the general public if sociologists concerned themsleves with pragmatic questions of how to get by rather than second-guessing the next Soros or Paulson.

  7. Keith Hart Says:

    Thanks to Jose for bringing this great site to my attention.

  8. yuvalmillo Says:

    Ahh, ok. I see what you mean, I think (at least in the example): you talk about how changing in the political realm motivate the creation and/or reconfiguration of market devices.
    I really like the example that you give: you should talk with Mr. Someone more often! (and post the results)

  9. danielbeunza Says:

    Hello Keith — welcome to the blog and thanks for commenting. I appreciate your own experience and the thoughts on the midwesterners. It is also clear that we disagree as to what is more useful to “the general public.”

    Most importantly, I would ask you to be more explicit — you have written extensively about money, currencies and the politics. The world seems to be on the brink of a neo-protectionist currency war. Fresh thinking is urgently needed. Does your writing have any bearing on the present situation?

  10. Leon Wansleben Says:

    Hi there. I am just writing a paper for the upcoming convention of the German Sociological Association. The topic is the Greek debt/euro crisis and currency analysts’ following of that crisis. What struck me is that the analysts, early on, consider different alternatives of how to design a rescue package (preferring the IMF because of stricter conditionalities) and they rationalize FX markets’ ups and downs (for all economists an enigma) as evaluations of very specific political moves. Indeed, then, during crises, we observe a tight coupling that confronts orders of worth. The analysts also heavily responded to politicians’ criticism of “speculation”. I think they did so because the notion of “speculation” indicates financial markets to be no orders of worth. Thus, analysts’ writing, normally assumed as “advice for investors”, addressed issues of legitimacy and justification.

  11. danielbeunza Says:

    Leon — I would be very interested to read this paper. Is it in English and would you share it? If it is in German, perhaps you would be interested in writing a post on the blog summarizing your views?

    As for the substance of your comment, I am particularly interested in the idea that in a crisis there is a tight coupling between orders of worth. This is similar to Abolafia’s paper on the silver bullion crisis, and how it was triggered by political maneuvering within the market on the part of speculators with the aim of extracting the biggest possible surplus. Is that what you have in mind.

    Thanks for the comment and do tell us more.

  12. Leon Wansleben Says:

    Dear Daniel, thank you for your comments. I had to assemble the paper (written, unfortunately in German) first before being able to reply to your questions.
    My question was not to explain the Greek debt crisis (although it would be another interesting case for social studies of finance). I only wondered why analysts engage in debates about what would be the best rescue package for Greece and whether or not speculation was a driving force during this episode. My answer was that during the crisis general lines of demarcation between markets and politics dissolved: The sustainance of the markets surely depended on the rescue package because if souvereign payment promises were not met, the European banking system would suffer. At the same time, politicians became increasingly depended on markets: The Economist writes that “’Ministers now look anxiously at their country’s bond-market spread against Germany just as their predecessors used to monitor their currency’s exchange rate against the D-mark’“ (2010.09.23). The analysts experienced this breaking down of the border between markets and politics, for instance, in the way the media reported about subjects that they regarded as “their” jurisdiction: Politicians were now quoted about “speculation”. The analysts responded to this situation by disqualifying the politicians with reference to the order of worth (Boltanski & Thévenot) that ultimately defines the market – as a legitimate (!) order based on the freedom to pursue one’s interests in situations of competition. One might rationalize this action by saying that, only as experts of a legitimate order of worth, analysts can maintain their own professional status and competence.

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