Cookies and Zilch
One of the frustrations of the Christmas season, for someone trained in basic mathematics, is the tradition of the holiday cookie exchange. In this tradition, a collection of friends and/or acquaintances comes together for a night and exchanges cookies they have prepared for cookies that others have prepared. This results in every person who came with cookies of one type leaving with a rainbow of cookie types. And thus, we illustrate the “gains from international trade” to the masses.
One of the reasons the cookie exchange tradition is frustrating is that there are always several participants, and often the organizers, who seem never to understand a basic principle: cookies are not created in the exchange. I remember an incident a few years ago when an exchange participant was enthusiastic about one particular event because she said ‘this way I can get so many cookies!’ How many cookies are you bringing? I asked. Two dozen, came the answer. How many do you expect to leave with? ‘I don’t know…maybe three, four dozen!’
This obviously can’t work, and it’s easy to illustrate. Suppose only one person comes to the cookie exchange, and he brings 10 cookies. In that case, he obviously leaves with 10 cookies. Suppose two people come to the cookie exchange, and they each bring 10 cookies. Then they switch cookies, and each person leaves with 10 cookies. Suppose four people come with 10 cookies. Each hands 5 cookies to the person on his left and 5 cookies to the person on his right. They all receive 5 cookies from the person on the left and 5 cookies from the person on the right, and they all leave with 10 cookies. We can generalize this: if n people bring q cookies to a cookie exchange, then on average (assuming no one eats any), each person will leave with q cookies. The n doesn’t matter.
Which brings us to Europe.
What Europe has is the cookie exchange, but they don’t understand how it works. Each country is showing up with 5 cookies and expects to leave with 10 cookies. It doesn’t matter if they route the cookies through the IMF: the number of cookies is fixed. You either need someone to bring a truckload of cookies which are distributed to everyone else (with Germany the driver of the cookie bus), or else everyone gets roughly the cookies they came with. There is no “cookie leverage.” Now, if some people show up with just a few cookies, and some with big bags of cookies, but they all leave with the average amount, then obviously some participants will enjoy this socialism and some will not (in the real-world cookie exchange, this takes place when all cookies are treated as equally valuable. The person who showed up with three dozen macaroons leaves with chocolate-chip, peanut-butter, snickerdoodles, ginger snaps…and the person who brought chocolate-chip cookies goes home with at least some macaroons. Where is the justice? Shouldn’t macaroons trade at a discount?[1] Those who bring great cookies end up losers while those who bring lame cookies end up winners.)
Strip away all of the structuring, and that’s fundamentally the problem. There is not enough money to service all of the debt, and no amount of shuffling money will solve that problem. And Germany’s decision to make is whether to bring dozens of chocolate-chip cookies and leave with macaroons, gluten-free rice-crispy treats, and that nut-flan-custard thing Grandma developed during the War.
So it wasn’t a huge surprise when on Friday there was nothing of substance announced to come out of the European summit. There were lots of statements given to the press. There was nothing there. Equities rallied (S&P +1.9%) because investors couldn’t really believe that was it. All we got from the summit we’ve been promised for weeks is a decision to move the ESM forward, although we don’t know how, and a reassurance that maybe some of the Eurozone will effectively cede fiscal sovereignty to the big guys, although we don’t know why?
When Monday comes, with no more headlines (unless the rating agencies go ahead and start downgrading sovereigns, as is almost assured now), I think there will be some selling pressure in the European equity and bond markets, and probably some spillover here in the equity side.
The other news on Friday was not good. Moody’s downgraded the French banks, and the ECB announced that it would limit its sovereign bond buying at €20bln per week (although it is still not clear they can do that for very long and continue to sterilize the purchases effectively).
I don’t think I am the only one who ended the day on Friday shaking my head in disbelief that there was no earth-shattering announcement. I didn’t expect any substance, but I thought they would make a better show of it. This is going to get ugly, and I have seen nothing that truncates the possibility that it could get epically ugly.
I guess that’s the way the cookie crumbles.
[1] I always thought this would be a great trading game – a tote board with bids and offers for, say, the gingersnap-snickerdoodle exchange rate.
Leave a Reply to loopy1969Cancel reply
Michael,
Lets assume there is a French/Italian bank out there. It has now “unlimited” ability to borrow / get funding from the ECB at what… 1 per cent? Wouldn’t it be motivated now to scoop up sovereign bonds at 6%, knowing full well that if all goes down the drain, it will be nationalized anyway / or “TARPed out”? There is simply NO other business for the banks in Europe now, is there?
Well, they’ve always had unlimited access to funding, provided they had collateral. So did Lehman! The question is whether the central bank allows blatantly insolvent banks to survive, and whether they have any other business. Most European banks are mostly doing unwinds of existing transactions these days, but that’s true of a lot of banks.
I think most of these banks already bought a ton of sovereign bonds back when they didn’t have to mark them to market if they were called ‘hold to maturity.’ It hasn’t worked out, and they’ll now have to take big writeoffs one way or the other. The capital markets will close to the weakest ones, and I suspect we will see some of them nationalized or forcibly merged, like Dexia.
Also, I hear talk that widely known technicians, such as Demark, have come out with their above 1300 S&P 500 calls on purpose, with a view to lure in as many in this bull trap as possible, so that their HF clientele can have a better 2012 short position entry point.
Are you of the same opinion?
I would be skeptical of that. Demark’s method is fairly transparent and hard to fake, but if he’s faking other calls just to help out his current clientele it’s very short-sighted since future clients will be fewer to come by if his current calls miss big. I think the folks saying that are just frustrated bears. I empathize with them, as a frustrated bear, but value will win.
Cookie hoarders seem to be the hold-up. Plus as we know you can’t spell socialism without Cialis.
good one!
I’ll gladly pay you Tuesday for a dozen macaroons today. (Just don’t ask me what Tuesday.) Also, macaroons are delicious! What do you have against macaroons?
I KNEW I’d get the macaroon defender here somewhere. Hopefully you’re not as devoted as the gold bugs. 🙂
I’m bringing my special, always delicious fantasy cookie. It doesn’t really exist, but if I talk about it long enough and promise it to everyone, I get other cookies with no downside right? What, people want their cookies back? I ate em. Sorry.
That was a great read, thank you.
Cookie exchanges are a special form of trading commodity… not only is the exchange zero-sum, but also zero-result as the underlying asset is 100% consumed. Possibly something that would interest crooked investment bakers as the only real-world example of a literal bankruptcy engendering positive Good Will.
miker
Brilliant comment!
Great! I actually understood this!
LOL – Thanks Mom! Your first-ever comment. I’m proud of you!