Trading in rumours

Date: 13/03/1997

IN THE long run, financial markets behave rationally.

They make governments pay for running up excessive debts, reward companies with high-quality managements and good products, and allocate capital at the best terms to the most deserving people.

The trouble is - as economist John Maynard Keynes once famously quipped - “in the long run, we are all dead”.

For the mortals who make a living from first driving the markets into a frenzy of excitement and then calming their fevered brows, each one of the mere 470 trading days left until the euro appears is going to feel like a lifetime.

Every day produces at least one rumour that EMU is about to be cancelled, postponed or systematically fudged. In the past fortnight, the stories have multiplied. Occasionally, the rumours are (sort of) true. But most are highly speculative and verge on the bizarre.

Take the one which kicked off the latest round of market turbulence.

Two weeks ago, on a Friday morning, the trading floor of the London International Financial Futures Exchange suddenly sprang to life. A rumour had spread among the young men in brightly coloured jackets, which soon spilled over into the screen-based markets for currency and government debt. Within an hour, the Italian lira had lost 1.5&percent; of its value against the deutschemark.

The story doing the rounds - if true - meant that investors had to get out of Europe's less reliable currencies such as the lira, the peseta or the escudo and back into rock-solid deutschemarks. For the word was that the Bundesbank had scheduled a press conference for later that same day at which it would announce a two-year delay to EMU.

This was a good story. It had everything - a named institution, a press conference and a specific time-period for the postponement. It was just the kind of tale that would be spun by a trader who was stuck in an awkward position on a Friday and faced the prospect of having to fund it through a long weekend. Instead, with one bound, he was free.

The fact that the whole thing was utter nonsense to anyone with even the most meagre knowledge of the Bundesbank's powers made no difference.

Put yourself in the position of a dealer from a small or medium-sized trading house. You know the rumour is eccentric and nothing fundamental has changed to make you sell one instrument and buy another. However, the market is moving fast and you do not have the presence to bully it back into line. So you opt to go with the flow.

'Buy the rumour, sell the fact,' comes high up in the trader's rule book.

It took three days for the lira to come back to its pre-rumour position. By this time, new stories were being bandied around the markets that German Chancellor Helmut Kohl was about to announce an EMU delay and, if he did not get satisfaction, he would resign. Or it may have been that his ministers were demanding a delay and he was going to resign if they managed to force him into such a decision. Traders are rarely specific.

This week, Kohl's meeting with Dutch Prime Minister Wim Kok was the focus for rumours that the two men were about to throw in the towel. Where better than The Hague and who better than Kok, as serving president of the EU, to announce a euro-postponement?

To anyone outside the markets, these rumours are mostly laughable. Journalists, in particular, like to sneer. Yet a similarly irresistible force is dictating the activities of these proud purveyors of truth.

At its root is the fact that their editors simply do not want to hear about the latest intricacies in the negotiations over establishing a monetary union.

They do not want to plough through budgetary estimates, public spending commitments and targets, and the vitally important (but often ignored) gross domestic product figures and forecasts.

Economic growth will not only boost tax revenues but it will also make the proportion of a budget deficit to GDP smaller. And this - not the absolute size of the deficit - is EMU's real ticket to ride.

Yet the ubiquitous Franco-German plot is so much more exciting. Kohl and French President Jacques Chirac have had little time to deal with domestic politics or the eastern enlargement of NATO because, according to the press, they have been far too busy devising pointless joint EMU schemes.

No financial journalist can earn his or her spurs without getting on to the front page with an unsourced story about a Franco-German plan to do something.

Two months ago, fashion dictated that we should all write stories about plans to create an EU economic government with tax-raising powers, to be known as the 'stability council'.

But fashions change. Now we should all be finding some lowly civil servant - to be cited, of course, as 'a senior official' - to tell us that Italy will not be allowed into EMU on day one or that Kohl and Chirac are plotting to delay monetary union by anything up to three years.

As if anybody knew. Plans like these are hatched as high as you can possibly go. Not even the people in the now legendary EU monetary committee or at the highest levels in finance ministries or central banks would know anything about them. If Chirac and Kohl wanted to delay EMU, only they and a handful of their closest confidants would even have a whiff of it.

The truth, as far as anybody except the two great men can possibly know it, is probably that no such plan exists. Why bother? There are still nine months to go and - as any pregnant woman can tell you - a lot can happen in nine months.

It may be that German unemployment will get worse and worse, increasing state pay-outs and making it impossible for Kohl to meet the crucial budget deficit target of 3&percent; of GDP by the end of the year.

Or, as the February jobless figures suggested when they were released last week, maybe the half-million increase in unemployment in January was a one-off caused by bad weather and an end to the construction boom.

Faced with rebellion in the political ranks over tax and pension reform, Kohl and his Finance Minister Theo Waigel are unlikely to try to push through another round of spending cuts or freezes but - with a fair wind - 3&percent; is achievable.

The French government's confidence is even more marked. If he is planning to postpone EMU, Chirac is making a good fist of pretending he is going ahead. Only last week, Paris announced another spending freeze worth 1.5 billion ecu in a last effort to hit 3&percent; in time.

If growth really gets under way in Europe this year, as predicted by many private-sector economists, the front-running 'core' candidates for EMU could just make it.

If the US dollar remains strong and boosts the competitiveness of European exporters, then the chances are even stronger.

And here we come to the crux. If the French and Germans announce that the euro will be delayed, investors will dump their dollars as well as their lire and buy deutschemarks in their droves, thereby undermining Europe's recovery.

So long as the euro is possible, prime ministers may as well keep aiming for it. If, by the end of the year, it is obviously a lost cause, then member states could choose to delay.

Economics Commissioner Yves-Thibault de Silguy constantly repeats that this is unthinkable and could even contradict the Maastricht Treaty.

Yet, as the EU has shown so many times before - from the decision to change the name of the ecu to the euro to arm-twisting the Danes into a second referendum - political will can always find a way.

For the best way, member states could do worse than read the latest research from investment bank Goldman Sachs.

While stating for the record that it still believes EMU will go ahead on time, the Goldman Sachs team puts forward the hypothesis of an 'empty shell' to launch the euro-bloc. Monetary union would still go ahead on 1 January 1999, but no members would join from the start. As and when convergence criteria were met in full, countries would opt in.

Now, that is a fudge.