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Politics : Idea Of The Day -- Ignore unavailable to you. Want to Upgrade?

To: IQBAL LATIF who wrote (44656)	9/21/2003 6:44:22 PM
From: IQBAL LATIF	Read Replies (1) \| Respond to of 50167

Why Are Financial Markets So Optimistic? Morgan Stanley's Steven Roach wonders why foreign exchange traders, gibbering in terror as they look at the U.S. trade deficit, haven't dumped the dollar, pushing it down in value. He also wonders why bond traders, gibbering in terror as they look at the budget forecast, haven't pushed long-term interest rates up further: Morgan Stanley: Which takes us to the critical question of the moment: What do financial markets see that the IMF and its like-minded sympathizers -- yours truly, included -- are missing? The main insight, in my view, is the presumption that global imbalances really don't matter at all. They are judged as the inevitable, benign, and even desirable outgrowth of yet another burst from the world's only real growth engine. For what it's worth, I continue to take issue with that key point (see my 2 September 2003 essay in Investment Perspectives, "Do Imbalances Matter?"). Imbalances, in my view, are tantamount to instability and fundamental disequilibrium. I would be the first to concede that such a state of disequilibrium is not life threatening in and of itself. But it does leave the economy, or economies, under question far more vulnerable to shocks than might otherwise be the case. To the extent such shocks are the rule, not the exception, I continue to be enamored with the case for an economic relapse in early 2004. Reading between the lines of the IMF's latest assessment of global risks, I suspect such an outcome wouldn't come as much of a surprise to them either. I think I understand the bond market: some bond traders think that American fiscal policy is about to come to its senses again in the next two years, either because George W. Bush will be replaced by a competent president or because George W. Bush will be forced to delegate economic policy to some competent and Rubinesque Grand Vizier; other bond traders think that the recovery will stall and investment will remain low, hence there will be little demand for capital. I also think I understand the relationship between bond market relative pessimism about investment spending and stock market optimism about profits and growth: they are different sets of people with different beliefs, and there are very few people with the money, the guts, and the risk tolerance to make the very risky long-term bets needed to try to make money off the inconsistency between the two sets of beliefs. What I don't understand is the foreign exchange market. I would not be holding dollar-denominated assets right now without also holding a large derivative position insuring myself against a major downward move in the dollar. Yet there are no signs that foreign investors have taken on such positions--no sign that anyone who has sold them their dollar puts has taken steps to lay off the risk on the rest of the market. Posted by DeLong at 07:23 AM \| Permanent Link