We’ll know in due course, now that an investigation is underway, why the equity markets in the US went into complete freefall for about twenty minutes, with the Dow dropping 998 points. Per Bloomberg:
Larry Leibowitz, chief operating officer of NYSE Euronext, said trades sent to electronic networks fueled the drop. While the first half of the Dow Jones Industrial Average’s 998.5-point plunge probably reflected normal trading, the decline snowballed as orders went to venues lacking liquidity to match them, he said
Yves here. Um, he seems to be saying there were more sellers than buyers, which we already knew. The idea that a fat-fingered trade out of Citi was the cause has been denied by the bank. The downdraft did have the look of a monster sell order, but the more credible explanation is that it was either a sudden rise in yen or the euro hitting the magic number 1.225 to the dollar that set off algorithmic traders. And enough of them look to similar indicators and technical levels that it isn’t hard to see this as the son of program trading, mindless computer-driven selling when the right triggers are hit.
But another side effect of today’s equity market gyrations is further distrust in the markets, particularly by retail buyers. I am told that various retail trading platforms were simply not operating during the acute downdraft and rebound. I couldn’t access hoi polloi Bloomberg news or data pages then either. The idea that the pros could trade (even if a lot of those trades are cancelled) while the little guy was shut out reinforces the perception that the markets are treacherous and the odds are stacked in favor of the big players (even though we all understand that, it isn’t supposed to be this blatant).
But the bigger issue, despite the stomach-knot-inducing drop in equities, is the wild gyrations across pretty much all markets. The credit markets were is disarray BEFORE equities took their cliff dive. Japan has pumped $21 billion of emergency liquidity into the market overnight, its biggest operation since 2008.
The Reserve Bank of Australia warned of the possibility of a sharp economic contraction…..and they are right. This is classic Keynes liquidity preferences. Keynes, a successful speculator, identified a crucial link between financial markets and real economic activity. When investors en masse retreat to the sidelines and prefer to hold cash or similar highly liquid instruments, the loss of risk capital and restrictions on lending are a blow to the productive economy. Accordingly, the G-7 has a conference call set, presumably which will lead to at least coordinated statements, perhaps some concrete action, to calm markets.
But how much can they do? Even if the eurozone manages to convince the markets for now that it has a credible plan to halt contagion (better frankly to clearly separate Greece, which is going to look ugly no matter what, from Spain and Portugal if at all possible), it is embarking on a deflationary path. That is going to affect the US on a host of fronts: via the impact on companies that do business in Europe (more than you think), via the decline in US competitiveness thanks to a weak euro. Think China will be willing to revalue the renminbi with the dollar strong? Don’t hold your breath.
The real question is what the ECB does, and Trichet’s refusal to commit to action on Thursday set off the currency moves that appear to have triggered the equity plunge in the US. Reader Hubert, who is no fan of the Anglo-Saxon “kick the can down the road” credit system, nevertheless believes that the least bad way of the current mess is for the ECB to deploy its balance sheet: “Politicians are behind the eight ball here. Either they subvert the ECB here and now in 2010 into this giant SIV or the Eurozone is going to blow up.” If enough investors believe that, bond spread widening and capital flight can make it a self-fulfilling prophecy.