Why Egypt Matters
Warning: There are political opinions expressed along with market opinions below. If your sensibilities are inflamed by reading political opinion, please do not read the comment today. Thank you.
What I know about Egypt would fill several lines of text. It has pyramids, and most of a sphinx. It is led by Hosni Mubarek. And it purportedly supports, at last check, American policies in the region and helps restrain the passions of Islamic extremists.
Here is why, in my incredibly uninformed view, we ought to support the desire of the Egyptian mob for more freedom. It is really just two lessons of modern history. (1) Democratic nations don't start wars. Now, our State Department would say "perhaps this is true, but we need a 'supportive regime' in place in Egypt." This brings me to (2) democratic nations don't fight other democratic nations, which is really more important. It is fine to say that Mubarek supports us now, but who is to say if he, or whoever succeeds him, will support our aims tomorrow? It seems to me to be a better idea to have a structural impediment to war than a personality-based impediment to war. (Incidentally, Wikipedia has a good article on the history of these two points under the header "Democratic peace theory.")
This uprising in Egypt is supposedly "inspired by an uprising that ousted Tunisian President Zine El Abidine Ben Ali on Jan 14." In other words...democracy is spreading throughout the Islamic world. (I wonder if anyone will give credit to a certain former President who argued this would happen, to much loud scoffing at the time as I recall?) Actually, U.S. Vice President Joe Biden says that Mubarek isn't a dictator, so if that's true then I guess my observation about democracy spreading is incorrect. I guess Mubarek is just a president who has held his post for 30 years and puts down uprisings with the military. It is interesting that much of the frustration coming from the crowds in Egypt, as it was in Iran, is directed at the U.S. lack of support for the movement. (Which is totally unfair! The Obama Administration has moved bravely and aggressively to encourage Egypt to restore citizens' access to Facebook! What more could people want?)
I don't generally write about politics in this column, because when I do many readers get very upset because they feel they are entitled to an opinion-free blog. However, I write about political events that impact markets, and that is the case today. What do we as investors - a category that encompasses citizens of hundreds of countries bring with them a riot of languages and religions and customs - want in Egypt?
Stability. We want stability. I don't think anyone will argue with that general statement. The question is whether we want stability tomorrow, or a situation that gives us more stability in the future. Choosing stability today at the cost of stability tomorrow is what the Fed has done repeatedly over the last twenty years, and it hasn't worked. Choosing stability today at the cost of huge debt tomorrow is what the last two Administrations did with regard to the current crisis, and while in some sense it has worked we may not know the costs for a while. Stability in the Middle East and in regions where Islam is the dominant religion is in investors' best interest. The question for us is: do dictatorships or theocracies or democracies lead to more stable growth, trade, and development outcomes? The evidence seems to be clear: there is a strong correlation between economic freedom and economic growth. The huddled masses yearning to breathe free are the same huddled masses which yearn to have an iPhone.
Today's unrest in Egypt happened to correspond with the piercing of 1300 on the S&P and 12,000 on the Dow, and as I noted yesterday such milestones often serve as good way-stations for investors who want to hop off the bus. I don't think we sold off 1.8% on the S&P (with the heaviest volume of the year so far) because of riots in Egypt. I don't think we sold off because Crude Oil rose 4.3% and Gasoline rose 3.0%. We certainly didn't sell of because the GDP numbers were near expectations (with strong Personal Consumption) and inflation in the form of the Employment Cost Index was restrained (+0.4% annualized). But the fact that these factors hit at week's end when an extended market was pressing past psychological way stations produced a fairly potent mix.
Bonds rallied again (to 3.33% on the 10y note) but inflation swaps rose 2-5bps - usually these move in opposite directions. The dollar had a mild bounce, and the fact that it didn't bounce more, and that bonds didn't rally more, than they did is one reason to think that the equity decline isn't entirely a consequence of geopolitical uncertainty.
Speaking of stability, I was amazed at the article in the Journal today, "Report Details Wall Street Crisis" and especially the part where Chairman Bernanke apparently had said that twelve of the top thirteen financial institutions in the U.S. were close to collapse in 2008 (the exception, of course, being JP Morgan, the eager bride in the Bear Stearns shotgun wedding). "Even Goldman Sachs, we thought there was a real chance that they would go under."
If you want to give Bernanke plaudits for anything, it was that he kept trying things until he hit upon the Commercial Paper Funding Facility, whose implementation finally stopped the cascade of the crisis. The question is why he did not then unwind the expansive and expensive policies that didn't really have much effect. But that's not important today. The authoritative history of the crisis will not be written in 2011, but more like 2020.
The more pertinent point is that it is hard to imagine that 12 of the 13 financial institutions were on the verge of collapse two and a quarter years ago, but are all doing great now. Was he exaggerating about 2008? Or is the Fed exaggerating about how well their wards are doing now? My suspicion is more the latter than the former, but who knows?
On Monday, Personal Income and Spending (Consensus: +0.4%/+0.5%) for December and the Chicago Purchasing Manager's Report (Consensus: 64.5 from 66.8) for January will be overshadowed by any posts from Egypt. If the streets are quiet on Monday, expect the market to rally - although, I expect, nervously. If the streets are still thick with rioters, then...