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Eric,

Thanks. This is a very good article and as you know we did run a short
program tracking the top rungs of the German elite ( mostly
political). I think the message of political risk can be applied to
any country but of course some countries or regions are more
important. I will pass this on to some of the people we saw in
Australia concerned about the expanding nature of political risk.

Michael

On Jul 27, 2010, at 6:58 AM, Eric Schwerin wrote:

> Saw this column in the New Yorker from a couple of months ago and it
> seems to give a perfect explanation as to why there is a need for a
> Vide like product. Not sure if anyone else saw it but wanted to
> share. Worth reading.
>
> THE AGE OF POLITICAL RISK
> by James Surowiecki
> MAY 24, 2010
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>
> KEYWORDS
> Political Risk; Greece; Germany; European Union (E.U.); (Prime
> Minister) Angela Merkel; Bailouts; International Monetary Fund
> (I.M.F.)
> t seems crazy: the German state of North Rhine-Westphalia holds an
> election, and Americans’ 401(k)s go haywire. But that’s not a bad
> shorthand description of what’s happened to the stock market over
> the past few weeks. What links the two is the Greek debt crisis and
> the actions of Germany’s Prime Minister, Angela Merkel, the villain
> of the story. When the scale of Greece’s problems first became
> clear, she grudgingly agreed to help with a bailout. But in the
> spring Germans started to ask why they should pay for Greek
> fecklessness and, as elections loomed, Merkel began taking a harder
> line in her public comments. The tougher she talked, the more
> skittish markets got. On April 26th, Merkel gave a speech in which
> she said, “Germany will help if the appropriate conditions are
> met,” making it sound as if that help were far from a sure thing.
> The yield on Greek debt immediately soared, and within days a rout
> was on. It may well have been the most expensive “if” in history.
> The European Union did eventually come through with a rescue package
> for Greece and other beleaguered members, like Portugal, but the
> markets didn’t calm down, rallying on Monday only to nosedive again
> at the end of the week. The fact is, this kind of volatility isn’t
> going away, because we now live in an environment dominated by what
> economists call “political risk”—the uncertainty that
> businesses face as a result of government actions. Of course,
> government actions always affect the economy, but usually in an
> undramatic way: an interest-rate cut here, a new regulation there.
> The economic downturn and the debt crisis have given us instead a
> world where governments are among the most important players in
> markets—injecting money into economies on a colossal scale and
> routinely propping up, or even nationalizing, troubled companies.
> As a result, investors have a vast range of new things to worry
> about, like voter sentiment in Westphalia. They have to try to
> figure out whether policymakers will do things they shouldn’t, like
> slash spending during a downturn, and not do what they should, which
> is to intervene promptly when systemic crises appear. Unfortunately,
> this sort of thing is inherently harder to predict than, say, how
> Procter & Gamble is going to do over the next few years. Last week,
> Mohamed El-Erian, the C.E.O. of the bond giant Pimco, sent a letter
> to investors saying that “the new normal” is a world in which
> “the public sector plays a much more influential role.” That’s
> a more uncertain world and therefore one in which markets will be
> more volatile.
> Political risk is hard to manage because so much comes down to the
> personal choices of policymakers, whether prime ministers or heads
> of central banks. And those choices aren’t always going to be
> economically rational—witness Merkel’s recent tergiversations.
> Similarly, the U.S. government’s failure to bail out Lehman
> Brothers in 2008 seems to have been in part the result of Treasury
> Secretary Henry Paulson’s desire not to be seen as Mr. Bailout.
> Investors, then, are being forced to read the minds of policymakers—
> not something they’re good at. Markets work best when there’s
> lots of information available and a historical track record to go
> on; they excel at predicting things like horse races, election
> outcomes, and box-office results. But they’re bad at predicting
> things like who will be the next Supreme Court nominee, as that
> depends on the whim of the President.
>
> FROM THE ISSUECARTOON BANKE-MAIL THIS
> Also injecting uncertainty is the fact that, even when politicians
> do the right thing, timing is all. Take theTARP bailout plan.
> Congress rejected it the first time around, in the fall of 2008, and
> the Dow fell nearly eight hundred points in a day. TARP passed on a
> second attempt, but by then the damage was done: fear and risk
> aversion had spread, and the stock market tumbled fifteen per cent
> more in a week. The bill for the Greek bailout has ballooned as a
> result of similar delay. In March, people were talking about a
> commitment of twenty-two billion euros. By early May, the E.U. and
> the I.M.F. planned to come up with a hundred and ten billion euros.
> Now more countries need bailouts and the total cost is seven hundred
> and fifty billion. The initial estimates were certainly too low,
> but, had Merkel acted sooner, the bill could have been a lot cheaper.
> Politicians do sometimes do the right thing at the right time, but
> that’s no easier to foresee. In 1995, with Mexico teetering on the
> edge of default and threatening to take down much of Latin America
> with it, the Clinton Administration conjured up a back-door twenty-
> billion-dollar loan bailout that stabilized the Mexican economy. In
> 1998, when Hong Kong came under attack from speculators who believed
> that its currency and stock market were overvalued, the government
> daringly put enough money into the stock market to send the hedge
> funds packing. And, just last year, the Obama Administration’s
> decision to stress-test the country’s biggest banks and require
> them to raise capital from private investors, rather than simply
> nationalize them, was instrumental in stabilizing a falling market.
> But in each case it was far from clear that the action would really
> happen—all three decisions were subject to vituperative criticism—
> so unpredictability still reigned.
> Political risk adds new complexity to markets, and, as Nassim Taleb,
> the author of “The Black Swan,” recently said to me, “As the
> system gets more complex, it becomes harder to forecast.” Claire
> Hill, a law professor at the University of Minnesota, argues that
> investors trying to manage political risk have historically moved
> between extremes of “optimism and skittishness,” which sounds a
> lot like the current situation. That doesn’t mean you should put
> your money in gold; over time, even volatile markets can rise. But
> it won’t be a smooth ride. ♦
>
>
> Eric D. Schwerin
> eschwerin@rosemontseneca.com
>
> Sent from my iPhone