Wednesday, August 3, 2011

Strike Three!

The naturally optomistic bias of the human mind is such that when someone speaks of convergence, the assumption is always that the process will involve bringing the inferior to the level of the superior, improve the condition of the less fortunate so that it more closely approaches that of their betters.  Why should that be?

Consider, for a moment, the issue of political risk in investing.  In orgies of reflexive self-congratulation, rich investors residing in rich countries have for decades assured themselves that investments in poorer, more primitive places carried with them a political risk and required a discount that was unnecessary in countries that were more economically advanced, more politically stable and (generally) whiter.  Proponents of investment in economically poorer, politically more tumultuous and (frequently) off-color countries enthusiastically argued that progress towards elected governments, free markets and rule of law reduced these risks (and the required discount), as those lesser breeds made steady progress towards the Olympian heights of the developed world's commercial splendor.

But perhaps the convergence is trending in the other direction.  Without regard for whether conditionas are improving in the emerging market countries or other parts of the world, perhaps the developed world is experiencing a deteriorating set of political conditions such that there is now political risk associated with investments in the United States or the Eurozone similar to that traditionally associated with Brazil or India.

Consider this summer and last summer.

Strike One!  The treatment of BP during the oil spill in the Gulf of Mexico over the summer of 2010.  Four companies were deeply involved in that situation.  BP owned a 60% interest inthe lease and was the lease operator.  An American company owned the other 40% of the lease and at one point started baying with the hounds.  Another American company was the drilling contractor.  A third American company manufacturer the blowout preventer that failed to prevent the blowout.

Of those four companies, which one bore the brunt of the assault?  The foreign one, of course.  A classic exercise in Banana Republic allocation of political blame.  Although that wasn't the limit of the political risk.  Anyone with an economic interest in oil and gas drilling and production in the Gulf of Mexico found that interest buffeted for months.

Strike Two!  The PIGS in Euroland.  Who would have thought that the arrest on sexual assault charges of the front-runner in next year's French presidential race would almost disrupt the elaborate quadrille under way to hold the Euro together, save the Franco-German banking system and make the indolent South pay for its sins?  Fortunately Christine LaGarde can pronounce 'exorbitant seigneurage' (in English).

Strike Three!  The circus just ended in Washington D.C. over raising the federal debt ceiling.  Wilful sovereign default (which may not even be possible in the United States) is all about political risk.  There is not a financial metric on the planet that can address it.

No more need be said.