An old chess anecdote tells of how the Russian master, Nimzowitsch, was unsettled when his opponent took out a cigarette case and placed it next to the chess board during a match. Nimzowitsch, who hated cigarette smoke, immediately called the organizers and lodged a complaint. The poor officials argued that as the man had not lit up and there was no smoke there could be no complaint. “I know” retorted the great Nimzo, ‘but he threatens to smoke and you know as well as I, that in chess, the threat is stronger than the execution’.
As in chess, so may it be in markets, especially in the world of Central banks and Sovereign Treasury Departments. Hank Paulson, the former US Treasury Secretary famously asked Congress in June 2008 to authorize him to use unrestricted amounts of federal money so that, well, he wouldn’t have to. “If you have a bazooka in your pocket and people know it, you probably won't have to use it” he pleaded, in an attempt to get government money to shore up the troubled mortgage agencies Fannie Mae and Freddie Mac. That part didn’t go exactly to plan – not only did he have to use his bazooka but was soon in front of Congress again asking for far more ammunition in the form of TARP to calm the panicked markets. Soon the Fed joined the action and after many rounds of quantitative easing and near -zero rates seems, based on recent data, to have finally put the US on a firm path to recovery.
Whatever it takes, but when?
Political realities make such coordinated action between fiscal and monetary policy virtually impossible across Europe. As a monetary union alone, it has been left primarily to the ECB to shoulder the responsibility of steadying the Eurozone economy. Draghi is a past master at using the vague threat of action to beat markets into submission. “We’ll do whatever it takes” he claimed in 2012 to stop the market tailspin and hasn’t yet been forced to spend a single euro on buying European Sovereign Debt.
The market has a funny way of testing the credibility of repeated threats. The fear in many investors’ minds must be ‘Will Draghi’s cigarette case turn out to be empty?’
For UK pension schemes, empty threats and unclear actions in the Eurozone have contributed potentially a large share to rising liabilities as long term gilt yields have fallen by more than 1% over the last year. Such volatile environments further highlight the importance for pension schemes to focus on clear objectives through a robust framework of managing investment risk rather than waiting for Draghi to open his Cigarette Case.
Please note that all opinions expressed in this blog are the author’s own and do not constitute financial legal or investment advice. Click here for full disclaimer.