In his 1995 novel Bombardiers, Po Brosnan describes how a bunch of bond traders decide to securitize a small central American country, without bothering to tell its government or people. It was entirely in keeping with the free-market zeitgeist, where politicians and people were powerless and Masters of the Universe like Sherman McCoy and Gordon Gekko ruled the world.
The financial crisis brought this hubris crashing down. Governments and central banks still cannot buck the markets, as Mrs Thatcher was fond of reminding us, but they can certainly move them.
Not in the old-fashioned way. Governments no longer dictate industrial policy, impose exchange controls, run strategic industries or set interest rates, as they once did. Few chancellors would dare to talk openly of "squeezing the rich until the pips squeak". Instead, politicians and central bankers influence asset prices by altering market perceptions of risk, and thereby modulating risk appetite.
We've seen this already this year. Just look at how the US markets advanced in anticipation of the Federal Reserve's $600bn "QE2" announcement, how peripheral European bond yields spiked higher when Angela Merkel proposed a sovereign debt resolution mechanism, then eased back when Jean-Claude Trichet merely hinted that the European Central Bank would buy up sovereign bonds.
And we'll see lots more of it in 2011. So many of the key questions – will the euro remain intact? Will China allow the yuan to appreciate? Will the Fed print more money? Will Japan ever get a grip? – are in the hands of politicians and central bankers, not investors. As Guy Monson, chairman of the investment policy committee at Swiss private bank Sarasin, notes: "Investment managers will need to become astute political analysts as governments increasingly drive the financial market agenda".
Such geopolitical ructions may seem remote from us individual investors. Someone who owns a few hundred Tesco shares may care little about China's exchange-rate policy or the intricacies of the European Financial Stability Fund. But globalization means such things are more connected than ever. Wage inflation in China feeds into the price of clothes in Primark. Free money from the Fed is debasing the dollar and pushing up commodity prices, keeping inflation high and real interest rates on our savings low. The travails of the eurozone affect the bond markets, and bonds set the price of just about everything.
The following pages take a detailed look at many of these issues, and how they will affect the key asset classes in 2011. We undertake this exercise every year with a keen awareness of a fundamental investment truth: that the future is inherently unknowable and unpredictable. But the fact that we do not have all the answers should not prevent us from asking the questions.
