Feb 13/15 – No, just very, very good…

2015-02-13 9am EDT  |  #deflation #EU #game theory #Greece #inflation #Liars Poker #Varoufakis

The other day the Greek Finance Minister gave the following sombre quote

“…game strategy is for games. You don’t play with Europe’s future, you don’t play with Greece’s.”

When I saw the Varoufakis’ quip, the opening story of Michael Lewis’ terrific book Liar’s Poker immediately sprung to mind. The story tells the tale of the Solomon Brother’s CEO John Gutfreund’s challenge to John Meriwether in a game of Liar’s Poker.

This day in 1986, however, Gutfreund did something strange. Instead of terrifying us all, he walked a straight line to the trading desk of John Meriwether, a member of the board of Salomon Inc. and also one of Salomon’s finest bond traders. He whispered a few words. The traders in the vicinity eavesdropped. What Gutfreund said has become a legend at Salomon Brothers and a visceral part of its corporate identity. He said: “One hand, one million dollars, no tears. ”

One hand, one million dollars, no tears. Meriwether grabbed the meaning instantly. The King of Wall Street, as Business Week had dubbed Gutfreund, wanted to play a single hand of a game called Liar’s Poker for a million dollars. He played the game most afternoons with Meriwether and the six young bond arbitrage traders who worked for Meriwether and was usually skinned alive. Some traders said Gutfreund was heavily outmatched. Others who couldn’t imagine John Gutfreund as anything but omnipotent-and there were many said that losing suited his purpose, though exactly what that might be was a mystery.

The peculiar feature of Gutfreund’s challenge this time was the size of the stake. Normally his bets didn’t exceed a few hundred dollars. A million was unheard of. The final two words of his challenge, “no tears, ” meant that the loser was expected to suffer a great deal of pain but wasn’t entitled to whine, bitch, or moan about it. He’d just have to hunker down and keep his poverty to himself. But why? You might ask if you were anyone other than the King of Wall Street. Why do it in the first place? Why, in particular, challenge Meriwether instead of some lesser managing director? It seemed an act of sheer lunacy. Meriwether was the King of the Game, the Liar’s Poker champion of the Salomon Brothers trading floor.

Don’t forget that this was in the eighties when a million dollars wasn’t something you just stuffed in the pocket of 28 year old HFT specialist as loose change. Back then, a million dollars was real money.

The code of the Liar’s Poker player was something like the code of the gunslinger. It required a trader to accept all challenges. Because of the code which was his code John Meriwether felt obliged to play. But he knew it was stupid. For him, there was no upside. If he won, he upset Gutfreund. No good came of this. But if he lost, he was out of pocket a million bucks. This was worse than upsetting the boss. Although Meriwether was by far the better player of the game, in a single hand anything could happen. Luck could very well determine the outcome. Meriwether spent his entire day avoiding dumb bets, and he wasn’t about to accept this one.

“No, John,” he said, “if we’re going to play for those kind of numbers, I’d rather play for real money. Ten million dollars. No tears.”

Ten million dollars. It was a moment for all players to savor. Meriwether was playing Liar’s Poker before the game even started. He was bluffing. Gutfreund considered the counterproposal. It would have been just like him to accept. Merely to entertain the thought was a luxury that must have pleased him well. (It was good to be rich.) On the other hand, ten million dollars was, and is, a lot of money. If Gutfreund lost, he’d have only thirty million or so left. His wife, Susan, was busy spending the better part of fifteen million dollars redecorating their Manhattan apartment (Meriwether knew this). And as Gutfreund was the boss, he clearly wasn’t bound by the Meriwether code. Who knows? Maybe he didn’t even know the Meriwether code. Maybe the whole point of his challenge was to judge Meriwether’s response. (Even Gutfreund had to marvel at the king in action.) So Gutfreund declined. In fact, he smiled his own brand of forced smile and said, “You’re crazy.”

No, thought Meriwether, just very, very good.

There is no doubt in my mind that the Greek Finance Minister is also very, very good. Although he is unconventional, this guy is playing the game like a cagey veteran trader.

Here he is flying economy as he hustles from high level meetings all over Europe.

He fired all of his security staff claiming that since he is acting on behalf of the Greek people, he has no need to worry about his security.

He set expectations low so that his adversaries would view any conciliation as a win. In a leading German newspaper interview, he explained:

“I’m the finance minister of a bankrupt country”

Varoufakis might claim he is not playing games, but like any true master, he is simply making the game look easy.

Before accepting the job as Greek Finance Minister, Varoufakis was an economic professor, with a special interest in…. wait for it… game theory. I don’t think that Greek Prime Minister Tsipras could have picked a better individual for the task of negotiating with the EU.

Varoufakis has played this game like Anne Akiko Meyers performing with her $3.6 million Stradivarius. It has been a real joy to watch Varoufakis stick it to the EU on their own court.

As negotiations between the Greeks and the EU have proceeded, there are increasing signals the two sides are close to an agreement. I did not think the negotiations would go so smoothly, but if it proves to be this easy, it won’t be because the Greeks compromised. My guess is that the rest of the EU has realized the formidable foe they are up against, and they are rolling over.

If the EU accepts Greece’s deal, this will mark a monumental shift in policy. The idea of cutting to prosperity will be once and for all be dead on arrival. We will be entering into a new era with more expansionary fiscal policies. This will occur at a time when monetary policy is as loose as it has ever been.

The ingredients for an inflationary boom are all there. I know right now that seems preposterous, but the reason that monetary policy has been so ineffective during the past half dozen years is that it has been accompanied by a tightening fiscal policy.

Remember the US sequestration cuts? They were part of the reason that Bernanke felt he needed to do more QE. The famous Senator Schumer quote was the result of Democrats inability to stop the cuts:

Senator Schumer took his five minutes to give a short speech, bashing Republicans for blocking what he felt was bipartisan legislation. Citing that tax cuts, infrastructure investments, and other policies had failed, he urged the chairman to take any action possible at the time.

"Get to work Mr. Chairman," he said to Bernanke.

Fiscal policy has been working against monetary policy for some time now.

I think the rising up of the Greek people is as Churchill said, the beginning of the end. We will see more and more governments refusing to accept fiscal tightening. No longer will fiscal policy be working against monetary policy. In the coming years we will have both monetary and fiscal policy working flat out to stave off deflation.

We are in the midst of a secular bottom in disinflation. I know that seems nuts. Everyone is worried about deflation, not inflation.

But you mark my words, we are near the end of the deflationary panic. A year or two from now we will be laughing at how we ever worried about deflation.

On that note, I will leave you with one last thought…

No currency has ever collapsed because of deflation…