A year ago, the realities of the economy were just beginning to sink in. The situation that we know now as a Recession, Depression, bailout, or whatever you want to think about didn’t happen overnight, but realization of it came to most people very quickly, like a nightmare that hit just as the clock was chiming 3AM. We’ve been awake for a whole year yet, but the clock is only chiming four times and dawn is still hours away. Since we’re awake, why not spend the time thinking it through?
The first thing that always comes to my mind is how so many commentators continue to say that no one saw this coming. The truth is that many people knew what was happening, even people well placed in the world of economics. They seem to have one thing in common between all of them, namely a significant amount of international and/or foreign exchange (ForEx) experience. If you think about it, this explains not only why they saw it coming, but why they are so easily ignored.
The names Nouriel Roubini, Bill Gross, and John Mauldin may be a bit more famous now than they were a year ago, but they are still hardly household names. Each of them predicted as long as 2 years in advance just what would happen, each was ignored, and each has fared reasonably well through the downturn. I like to add Graciela Chilinisky in this group, since her work on game theory predicted just how risk management would fail – although it was in dense academic papers that didn’t exactly make the evening nooze. The only thing they have in common is their experience in international exchange.
I’ve been talking this out for a while, trying to figure out why ForEx was so critical to understanding just what was going down in advance. There are three key reasons that my friends and I have been able to come up with.
First of all, ForEx people are seen as specialists, but they are really generalists. A bet on a currency is a bet on a whole economy, so you have to understand a big picture right off the bat. You can’t focus on a narrow market segment and understand what’s going on in an entire nation.
The second thing that comes to mind is that ForEx managers have a lot of international experience. They have learned to look past different customs and procedures and learn what’s important. They have, to a person, great BS detectors, too.
The last thing is the downside of ForEx, which deals mainly with sovereign debt. That’s a fancy way of saying that a nation can just decide that they aren’t gonna pay it back, or that they’ll just print a lot of money, and there’s not much you can do with it. ForEx traders are masters at managing risk, one way or the other, because their ultimate risk is about as severe as it gets.
If these people are so sharp, why didn’t anyone listen to them? That’s where it gets interesting to me. To have a reliable bubble economy, people really have to start buying their own BS on a consistent basis. It’s especially easy to marginalize the people who don’t want to come to the party if they look like geeks and nerds. As long as ForEx is seen as nothing more than another strange technical specialty, there’s no reason to have them spoiling the fun.
But that’s where the downside gets even more interesting. We’re already looking at $1.50 to the Euro, which is a good 25% off the target that was set just 10 years ago when the single currency was launched. The US Dollar is only expected to get weaker. ForEx is starting to look like a hot prospect for the simple reason that the ties to the world economy that were once something like US edicts are now going to start moving the other direction. Its going to be hard to get other people to make stuff for us for the paltry price of whatever green stuff we can print.
Not only were the ForEx people right, they were right in part because we thought we could ignore not just them but everything they did. Their analysis is certainly valuable, but their outlook is going to be even more important. Are we paying the right attention to them a year on? Not yet. But we will.