Thursday, May 7, 2009

Policy Iceberg Problem - what is going below the surface matters


A concern is that many policy initiatives which are being employed around the globe will have mixed effects with different time lags. The iceberg effect comes with the announcement of a policy which is above the surface, but the details, timing, and funds still murky and below the surface. No doubt fiscal stimulus will have a positive impact, but the interaction across countries is more complex and causing mixed impact on currency markets. In the case of the US, the stimulus will total $780 billion but will come over a number of years. Consequently, we have the headline announcement effect but the real details is how and when the money will be spent. What happens if we start a recovery in the fourth, yet the stimulative impact of the government will come in 2010. The deficit financing is starting to impact rates markets which feedback on growth. What is the impact of the deficit financing. We are seeing more supply out the curve and longer-term rates are starting to increase.

The policy announcement at the G20 meeting concerning IMF funding is another perfect iceberg example. Providing more funding for the IMF gave emerging markets a boost, but the details of when and how the funding will be provided and the exercise of this new credit power by the IMF is unclear. Hence, the link between the underlying economics and markets is altered albeit in an unclear way. The question for any investor is whether you react to the announcement effect of steer a course based on what you think is below the surface. In this case, liquidity still may be scarce and the amount of money provided by the G20 to the IMF may actually be much less than what was announced.

The iceberg effect is another way of saying that there will be a law of unintended consequences. The unintended effect often comes after we see what is below the surface.



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