When Policymakers Become Extreme Reactionists: A Survival Guide For Investors

by Peter Atwater, Minyanville staff writer
Newton’s Third Law suggests that for every action there is an equal and opposite reaction. While that law may apply to the world of physics, his principle is of no use when it comes to politics. While there is no group that reacts with such consistency to the forces of social mood as policymakers and regulators, their reaction always runs with mood, not against it.
For investors and business leaders, knowing how policymakers will react to changes in social mood is critical. Changes in social mood alter our collective confidence and reshape our preferences and the choices we make. What works during a period of rising mood doesn’t work when mood is falling -- just ask the leaders of EADS NV EAD, BAE Systems BAESY, UPS UPS, TNT TNT, NYSE Euronext NYX, and Cerberus, not to mention recent investors in the Swiss franc and Japanese yen and short sellers of peripheral European debt. Being on the wrong side of a policymaker response to a change in social mood can be financially debilitating.
During periods of rising mood, policymakers consistently loosen rules and regulations. We saw this firsthand with both the creation of Glass-Steagall at a major bottom in mood in the 1930s and the law’s repeal near the peak of social mood in 2000. And in the UK, policymakers even coined the phrase “light touch regulation” to describe their hands-off approach to banking supervision at the peak of mood just prior to the banking crisis. That the top-10 global financial institutions in 2007 were of record size and complexity and offering innovative and often unproven products should hardly have been a surprise. All tie to peak social mood.
Given the deterioration in social mood since 2000, however, policymakers today operate not with a light touch, but with a very heavy hand, believing that through greater regulation and market intervention uncertainty can be eliminated, confidence restored, and economic prosperity renewed. And the abuses that occurred at the peak provide plenty of air cover for stricter rules. In a world of perceived uncertainty, the general population wants not only tighter policies, but also accountability for those who created the mess.
For business leaders and investors, however, it is not just stronger regulation that accompanies falling mood. History repeatedly shows that very weak mood brings with it increased political and regulatory nationalism, as domestic challenges take precedent over the concerns of others around the globe. That countries are now adopting beggar-thy-neighbor fiscal and monetary policies, anti-competitive trade practices (against foreign owned and controlled companies), and limits on immigration is to be expected. With weak mood, generosity is swapped for self-interest. And of late, as both Hungary and Japan reveal, thanks to very weak mood, self-interest now includes the coercion -- if not outright co-opting of -- national central banks as well.
So how can business leaders and investors navigate this extreme reactionist environment?
First, appreciate that until social mood improves, the seamless mobility of labor, goods, and services that typified the late 1990s/early 2000s are done. Transnationalism as a business model, like multinationalism in the late 1960s/early 1970s, will face serious headwinds. As Apple AAPL and Wal-Mart WMT have experienced “how” and “where” companies do business now matters. And in this weak-mood environment, picking on the foreigner -- whether it is Starbucks SBUX, Amazon AMZN, or Google GOOG in the UK for not paying their fair share of taxes, or Standard Chartered SCBFF and HSBC HBC here in the US for money laundering -- is a game everyone will play. Wal-Mart's announcement this week of an overt “Made in America” product campaign fits current social mood to a “T”, and so did the company’s decision in the summer of 2011 (when mood was even weaker) to offer local produce.
When the going get tough, it is all about being local, and no one knows that better than elected policymakers and appointed regulators. That Basel III, pan-European banking supervision and International Financial Reporting Standards are under attack today also fits perfectly with current social mood, and unless mood improves soon, not only will all three of these initiatives face headwinds, but they are likely to be cast aside for national alternatives. And to that point, I’d offer that not only did the EADS/BAE merger not stand a chance from a social mood perspective, but if European mood weakens further, there is a real risk that EADS itself comes apart. Socionomically speaking, EADS is to military suppliers as the euro is to currencies. Both came together at the top.
Regulation and M&A, though, aren’t the only policymaker-areas investors and business leaders should be attuned to. Having now largely exhausted investor and public sentiment toward further quantitative easing, unless mood improves, foreign exchange will become the next nationalistic policymaker battlefield. As the recent reaction to jawboning by Japanese and European leaders shows, however, investors and corporate business leaders face immense challenges managing what will be an extremely volatile policymaker environment as national leaders and central bankers play Goldilocks, wanting foreign exchange rates that are neither too hot nor too cold for economic growth and inflation. And as Switzerland shows, should foreign exchange rates move too far too fast, outright controls will become the norm.
For global business leaders, understanding country-specific operations will be critical as capital controls are also likely to be implemented alongside limitations on goods, services, and labor. Today, few transnational corporations report financial statements (earnings and balance sheets) by country. They would be wise to do so, particularly as investors will demand greater and greater country-specific disclosure should national limitations rise. As bank executives learned the hard way in 2008, the inverse correlation between scrutiny and social mood is all too clear.
Finally, to those hoping for long-term and long-lasting public policymaker responses to the current economic malaise, you are in for disappointment. When it comes to policymaking, “permanent” is a high social mood phenomenon. That public leaders are “kicking the can” with temporary stop-gap measures is to be expected, and appreciate that it will only be at extremes in mood that we will see leaders take any kind of decisive action. In fact, given policymakers’ reactionist behavior, they are far more likely to act after mood has actually changed direction than before. As we saw in Europe last summer with regards to peripheral debt CDS, however, the result is like gasoline being poured on a fire that has already started to burn.
Investors would be wise to appreciate this belated-policymaker response in their trading strategies.
While the financial media would suggest that everything we see around us from policymakers is “extraordinary” and/or “unprecedented,” from a socionomic perspective, neither is really true. Policymakers are doing what they always do. They are reacting to changes in social mood. By knowing how and when they will react, business leaders and investors can anticipate what's ahead -- whether mood rises or falls from here.

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