Introduction: Why the Markets Must Be Politically Investigated
“Democracy cannot be blackmailed”—so Alexis Tsipras, the Greek Prime Minister, declared triumphantly on the night of an extraordinary referendum. In a vote called just nine days before, the Greek public was asked to issue its verdict on the latest bailout proposal put forth by the country’s creditors. This group was owed the gargantuan sum of €323 billion, equivalent to 177 % of Greece’s GDP. On July 5, 2015, the Greeks voted against the bailout offer with a resounding NO, rejecting it by a margin of 61 %-39 %. Leading up to the referendum, commentators widely depicted the vote as a climactic moment in a struggle pitting Greece’s left-wing government against Europe’s more orthodox political and economic establishment, with the fate of the euro currency hanging in the balance. Economic and financial analysts drew the vote as a fight. On one corner of the ring was a small country desperate to end years of austerity, though still wanting to retain the euro; on the opposite corner was a larger set of countries, led by Germany, committed to enforcing the fiscal requirements of a continental currency. Underlying the entire drama, however, was a more fundamental crossing of forces. Tsipras’ words alluded to it: the interplay of democracy and financial markets.
At the time of the referendum, this dynamic was obscured by the fact that the confrontation had taken on a predominantly political cast. Aligned against the Greek government were other state actors, the so- called troika made up of the European Commission (EC), the European Central Bank (ECB), and the International Monetary Fund (IMF).
© The Author(s) 2017
G. Bragues, Money, Markets, and Democracy,
These now held the bulk of the Greek debt, rather than private investors and commercial banks in the financial markets. Yet back when Greece’s predicament first came to a head in the spring of 2010, it was precisely those investors and banks that stood chiefly exposed to the country’s debt in the form of Greek government bonds. With the euro then in free fall over concerns that Greece’s troubles were spilling over into Spain and Portugal, European Union (EU) leaders worked late into a Sunday night to come up with a rescue plan. Allegedly, the French president at the time, Nicolas Sarkozy, issued a threat to German Chancellor Angela Merkel that France would pull out of the euro unless Germany came onside. The result was an unprecedented €750 billion aid package, of which €110 billion was initially allotted to Greece. This would be the first of a series of measures—including a second bailout of €100 billion in 2012 and the purchase of Greek government bonds by the ECB— by which the debt wound up going from private hands onto the balance sheets of government entities. Paramount in all this was the goal of preventing the markets from forcing the collapse of the euro. “In some ways”, as Merkel pointed out early on, “it’s a battle of the politicians against the markets ... I’m determined to win”.1
Five years later, Tsipras tried to exploit this battle for his fellow citizens. He was spurred on by his finance minister, Yanis Varoufakis, a self-described “erratic” Marxist. The strategy that Tsipras and Varoufakis adopted involved the threat to unleash chaos in the world’s financial markets unless the troika gave Greece more lenient credit terms. But with the debt having been effectively off-loaded onto European taxpayers, the market reaction to the referendum result was relatively muted. Contributing to this, too, was that the other indebted countries under the market’s radar, Portugal and Spain, had already gone some way to reforming their economies in return for aid from the troika. Thus, on the day after the vote, Europe’s main stock exchanges in Germany, France, and the UK were down between 0.75 % and 2 %—a notable drop, to be sure, but far from a calamity. In the USA, after an initial decline in the morning, stocks ended up little changed for the day. Bond yields of Southern European nations went up merely by 10-20 basis points (0.1 %-0.2 %). As for the damsel in distress of this Greek drama—the euro fell by just 0.5 % versus the US dollar. 
No wonder the deal to which Greece ended up agreeing was more stringent than that which its people rejected. It was not simply that the Greek government was forced to cross its own “red lines” and submit to tax increases and pension cuts. It also surrendered to the establishment of an EU monitored fund into which the proceeds would go from the privatization of state firms. Equivalent to a trust fund, this arrangement was meant to ensure that Greek politicians would not redirect the money away from its intended use to repay the debt and shore up the Greek economy. Tsipras’ gambit had utterly failed. If democracy was not blackmailed, it was certainly humbled.
Few occasions reveal more starkly the connections between politics and the financial markets. Here was a situation in which a dire predicament faced by a government led it to bet on a market reaction by way of an appeal to the populace. Then, when the market did not respond as hoped, that government’s political counterparts were emboldened to stand firm. It was a political game of poker in which the cards that each side was given to play happened to be dealt by the markets—albeit with that deal itself tilted by earlier political moves.
This last twist underlines the thesis of this book: in the interactions between politics and financial markets, politics ultimately controls the relationship. The prices at which financial instruments get traded; the kinds of financial instruments that get traded; the individuals and institutions that get to trade them; not to mention the rules under which they get to trade, these are all matters decisively influenced by an array of political variables— sometimes for the better, but all too often for the worse. Though I risk unsettling many readers, the issue must be squarely faced: the fault for this political skewing of the markets lies chiefly with democracy. That skew can be corrected to some extent, but it is an extent bounded by democracy.
We need not go back too long in time to find another instance outside of Greece in which the confluence of politics and finance was plainly evident. In the fall of 2008, amid the throes of the sub-prime mortgage crisis, a viewer tuning to CNN could have watched a speech by then US presidentelect Obama alongside a small, specially placed shot of the Dow Jones Industrial Average (DJIA) ticker live from the New York Stock Exchange (NYSE). Then, too, policymakers sacrificed more than a few weekends to formulate various rescue strategies—whether it was for Bear Stearns, Fannie Mae and Freddie Mac, American International Group (AIG), or Lehman Brothers—that would meet the Sunday night deadline imposed by the opening of Asian markets. Nor was it hard at the time to discern the link between stock market movements and events in the US Congress. That legislative body was then busy debating the Bush Administration’s $700 billion bailout of the financial system known as TARP (Troubled Asset Relief Program). The House of Representatives originally voted down the legislation by the House of Representatives. When the news of that vote reached the stock exchange, the DJIA proceeded to tumble by 778 points, equal to a 7 % drop in the index.
Illustrative of all this is the chart below. It is based on data collected by the Policy Uncertainty Project, a research effort led by a trio of academics at Stanford University and the University of Chicago. Every time there was a minimum 2.5 % daily change in the US stock market, as measured by the Standard & Poor’s 500 (S&P 500) index, the next day’s market report in The New York Times was checked to see if the price movement was attributable to political events. Between 1980 and 2015, there were 298 trading days that fit this definition. And between 2008 and 2015, in particular, the percentage of those days’ price changes related to political factors were markedly up (Fig. 1.1).
One could counter this graph by observing that the number of large politically induced moves is still small when compared to the total number of trading days. Admittedly, from 1980 to 2015 that proportion is only 0.8 %. Nevertheless, it would be a mistake to infer from this that politics and finance only intersect in exceptional circumstances. The point of this book is to avoid this error. From the remarkable events I just related, it is admittedly tempting to conclude that an equilibrium normally separates the realms of politics and finance until one of them disturbs the balance by perpetrating trouble of some kind—say, by the government running up a colossal debt or by investors losing their minds in a speculative bubble that destabilizes the economy. Media accounts of the recent financial crisis often give this impression whenever they describe the markets as having operated in a laissez-faire zone until the collapse of sub-prime mortgage securities compelled the government to intervene.
Even more complicit in this illusion are the economists, who virtually monopolize the study of financial markets in academia. Their models and equations often bracket political forces, as is evidenced whenever they
Fig. 1.1 Percentage of Large Moves in S&P 500 Attributable to Political Events, 1980-2015. Sources: Economic Policy Uncertainty, 1980-2011; Author’s own calculations, 2012-20153
assume zero taxes in their theoretical constructs. In preferring elegant and quantitatively tractable theories, economists have long been addicted to the hope of imitating the success of the natural sciences. As a result, they have promulgated a vision of the markets as a kind of island floating independently within society. On this island, supposedly, individuals and firms compete in seeking to advance their pecuniary interests by trading a myriad of securities whose price changes are fully explicable in terms of the laws of supply and demand.
The more complicated reality, even if lost sight of in calmer and more propitious times, is that the financial markets are always and everywhere intertwined with politics. States and markets have often been set against one another as if they were distinct, autonomous forces opposing 3
Economic Policy Uncertainty, “S&P 500 Large Moves” (2012), http://www.policyu.ncer- tainty.com/sp500_moves.html; Scott R. Baker, Nicholas Bloom, and Steven J. Davis, “Measuring Economic Policy Uncertainty”, National Bureau of Economic Research Working Paper., No. 21633 (October 2015), http://www.policyuncertainty.com/media/BakerBloomDavis.pdf each other. Far from being separate, however, the markets are actually subordinate to the state. Though the markets can be a very formidable variable within the polity, and indeed may effectively capture the latter at times, it is nevertheless subject to the exigencies of the state and the wider social concerns it reflects. As such, the financial markets cannot be solely left to the economists. To attain a more complete view of what readers of The Wall Street Journal and The Financial Times try to grapple with every working day, we must examine the entire constellation of currencies, stocks, bonds, and derivatives under the light of politics.
This is what this book aims to do. As such, my intent here is something that will hopefully be of interest to a wider audience than is typically aimed at in writings that map the workings of high finance. This is not to say that financial economists will find nothing here to add to their understanding of the markets. If I have executed my task rightly, they will come away with a better appreciation of the political forces—both immediate and overarching—that drive security prices and government regulations. More importantly, they will end up with a stronger sense of the moral and social issues that financial markets raise from their being mostly ensconced in democratic polities. Such issues will, I hope, make this book of interest to business ethicists concerned with the moral dilemmas of contemporary finance. Beyond these groups, I have also kept in mind political economists, political scientists, in addition to the growing coterie of scholars from the other social sciences with an intellectual curiosity for things financial. And I very much hope that non-academic readers will find this book useful. Perhaps, they are financial market professionals trying to enhance their understanding of the political phenomena at work in their trade. Or, perhaps they are just thoughtful and publicly minded citizens grappling with the heightened role of financial markets within our democracies.
To compass all these groups, I have provided definitions and summaries of the key financial instruments traded in the markets. Hence, if you are unsure about some of the things to which I have already referred—such as bond yields, foreign exchange (FX) rates, or stock indices—you can be rest assured that I will explain these in the pages ahead. Also included are brief descriptions of the main players and institutions. Much of this, of course, will be familiar to financial economists and market practitioners. So to make it tolerable for this latter group, and simultaneously engaging for the remainder of my intended reading audience, I have tried to weave the explanatory portion into the political analysis, rather than having it laid out in a series of stand-alone sections. I have also endeavored to write as clearly as possible without sacrificing too much in conveying the real complexities that characterize our financial markets—complexities, alas, that intimidate all too many from even bothering to comprehend the larger significance of those markets.
-  Angela Merkel cited by Terence Corcoran, “How to Save Europe”, Financial Post, (May20, 2010), FP 11.
-  Duncan Robinson and Ferdinando Guigliano. “Asset Plan Shows Extent of GreekCapitulation”, Financial Times, (July 13, 2015), http://www.ft.com/intl/cms/s/0/9de1efb4-2976-11e5-8613-e7aedbb7bdb7.html#axzz3fpIJIDde