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BEWARE the things we tell ourselves, because it is the little lies that help us get through the day which come back to haunt us in one big go at the end. We all know them, the comfortable little ‘truths’ by which we hold ourselves together, rationalise our decisions even when their consequences have proven that they were bad decisions.
Stories and narratives by which we render a complex situation understandable play a big role in shaping the collective behaviour of herds. Anyone who has worked in financial services dealing with retail customers, or anyone who has worked in TV knows that there are few stories that sell better than those that tell people what they want to hear.
The weakness for having ears only for those stories that speak directly only to our own preconceived notions is not restricted to retail clientele. Even institutional buyers of stocks and bonds or regulators watching sharp swings in the markets can fall prey to such weakness.
We saw a recent example of this weakness when the Securities and Exchange Commission of Pakistan issued a press release about its report investigating the roots of the 2008 stock market crash. The final report is yet to be released, but according to the summary contained in the press release, the entire fiasco of the crash followed by the freezing of the market, was the result of a bad decision made by one man.
Money is once again fleeing equities and other emerging market assets in huge quantities. But it is not going into commodities.
That take on things back then was totally wrong, and it is important to understand that today because many of the same circumstances that led to the crisis are re-emerging. The take is wrong because the crash of 2008 was systemic and owed itself to systemic weaknesses such as an overleveraged stock market, excessive speculative inflows and volatile investor psychology.
We need a proper understanding of what happened in 2008 for a simple reason: to better understand how to prevent it from happening again, especially now that the rout in global markets is gathering steam. But all we have is a clever little blame game telling us it was all one guy’s fault and had he decided otherwise, everything would have been well.
This is the classic weakness mentioned earlier. When the consequences of a catastrophic decision come raining down, either the mind has to say “we screwed up big time”, which is hard, or it can simply say “everything would have been well had this fellow not done what he did”, which is easy.
It happens in other areas too, as in military misadventures. Look at how the official narrative has been built around the great misadventures that were launched to try and retake Kashmir by force, how each ended in failure. In each case, the official narrative said “everything was going well until this fellow did what he did”, rather than acknowledging that the entire venture was flawed and unworkable to begin with. It happens in companies faced with the consequences of catastrophic decisions, and it happens in households and families living with the facts of life when the chickens come home to roost.
The narratives doing the rounds about 2008 say two things. One version says it was the missteps of an “overzealous regulator” that led to the crisis. The other says a spike in oil prices led to a drainage of reserves, sparking the whole affair.
Both versions are flawed. The 2008 crisis happened because our markets had grown too fast for their own good, and the psychology behind the funds that were fuelling the rise was dodgy to start off with. The reserves did drain because of spiralling oil prices, but this price spiral itself was the result of massive speculative flows into oil, and gold and other commodities, as equities collapsed around the world.
This time something similar is happening, but with a slight variation. Money is once again fleeing equities and other emerging market assets in huge quantities. But it is not going into commodities. So we have collapsing stock markets around the world, as well as collapsing commodity prices. And this is hitting us in complex ways. Inflation is down, but rural producers are in bad shape due to collapsing commodity prices. State revenues have been hit hard due to declines in oil prices, but the current account has been buoyed as a result.
At this moment, few people see a threat to the stability of the macroeconomic framework in Pakistan due to the global rout and the large-scale withdrawal of liquidity from emerging market assets. But the big lesson of 2008 is that these things work in complex ways.
The sudden rush into commodities back then wasn’t foreseen by most analysts, and the oil price spiral, once it kicked in, had many wondering where it would end. The spiral depleted our reserves, which drew down bank liquidity and placed pressures on the reserves and fiscal stability as the state chose to absorb the brunt of the spiral rather than pass it on to consumers.
This led to panicked withdrawals from the banking system, leading eventually to a shutdown of interbank lending, pushing the financial system towards a state of extreme illiquidity, necessitating emergency measures such as the extraordinary monetary loosening, approaching the IMF and freezing of the stock market that came in close proximity to each other.
The right lessons from 2008 can help us be better prepared should the ongoing bout of volatility sweeping global markets continue and accelerate, because financial markets are complex creatures and volatility can jump from region to region, or from one type of asset to another in ways we cannot predict.
Perhaps this is why we are being urged, by the Fund and the State Bank, to be more careful with the reserves, to strengthen the buffers, because that is the doorway through which the crisis entered the mainstream of our financial system the last time round.
The writer is a member of staff.
Twitter: @khurramhusain
Published in Dawn October 1st, 2015
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