Speculative thoughts

Democratic governments are designed and exist to promote and protect the interests of their population. Thus they tend to be described as “good”. Capitalists are seen to be out for themselves and therefore acting in their own selfish interests. They are often described as “bad”. However, in order to have a prosperous society one has to combine the socialism and fairness of democracy with the efficiency and ruthlessness of capitalism.

These two forces come together in the government bond market. On one side is the collective need to borrow to provide for your citizens needs (health, education, defence, etc) and on the other are capitalists who provide the finance for government spending. These capitalists can be described as either investors or speculators.

Investors are generally seen as good capitalists, while speculators are seen as bad capitalists. This line of thinking has once again come to prominence with the market’s attempts to value Greek debt, with holders of the debt who think it is undervalued described as benevolent investors, while economic agents who think the debt is overvalued (expressing their view through credit default swaps) described as devilish speculators.

European governments are now looking to see how they can regulate speculative investors who have used CDS to express a negative view on Greece’s ability to pay its debts. They argue that Greek government bondholders might actually want to see Greece default on its debt due to their holding of CDSs. It has been noted that CDS holders might be incentivised into pushing for Greece to enter default. Additionally – because the CDS market is over-the-counter – there is no way of finding out who the protection buyers and sellers are, adding to uncertainty and volatility in markets. The  investment community counters these arguments by saying it should have the right through CDS to promote the efficient allocation of capital.

Putting the various arguments aside, let’s assume the governments win – after all, they regulate the market and can determine what contracts are legal. This banning of CDS would eliminate the tool of CDS for speculators to express a negative view, but would also eliminate the potential for speculators (investors) to express a positive view. If it is seen that the banning of negative CDS trades is a net positive for governments and society then governments could then move a step further and seek to ban the shorting of government bonds physically or through the use of the futures market. If that works then governments could progress to stop the shorting of national currencies as that position is the most aggressive step capitalists can take against a nation state. If that works then governments could stop criticism of their national finances. If that works… I think you know where we would end up!

This is the essential conflict between the state and the individual; are you an individual/speculator who is up to no good, or are you an individual/speculator who challenges the status quo for good? Should CDS on governments be transparent and not abused? Yes. Should it be banned? No. The CDS market should be a fair and level playing field. If governments think that CDS are mispriced then they should take the same response as they do in the FX market i.e. behave responsibly, influence the debate verbally, and then strongly intervene with the only medicine speculative capitalists respect, real money.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Richard Woolnough

Job Title: Fund Manager

Specialist Subjects: Government and corporate bonds

Likes: Running, cycling

Heroes: Mohammed Ali, Winston Churchill

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