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Sitting quietly

Blaise Pascal – for how long can he sit quietly?

At this stage in the coronavirus crisis, many of us consider ourselves experts on pandemics and biology. The speed of the coronavirus through our world is paced by the speed at which our concern and curiosity is fuelling a quest for information.

One thread that has become evident to me, is that historically epidemics have not always been greeted with calm and grace. In periods when medical knowledge was not as well developed as it is now, and when democracy and public health education were fledgling, epidemics were often met with violence and disorder.

For example, in the early 1830’s cholera spread across Europe but efforts to contain it in countries as diverse as Scotland, Prussia and Russia were greeted with public attacks on doctors, nurses, and quarantine officers. At times, anyone in a white coat was a target. The general fear was that authorities were using the cholera epidemic to poison people so as to reduce the burden on the state or that doctors simply wanted cadavers for anatomy schools. We trust experts more today!

Compared to the nineteenth century, what is remarkable today is the degree to which populations – mostly in Asia and Europe so far – have followed the lockdown guidelines. In general, adherence to the lockdown has been highest in countries where trust in government (and perhaps fear in some cases) is greatest.

The next stage of the crisis, coming over the next two weeks, will severely test this trust. Whilst I am now tired of reading commentators quoting Blaise Pascal’s ‘All of humanity’s problems stem from man’s inability to sit quietly in a room alone’, millions of people across the world will face severe stress in terms of how they sustain themselves. This much was made clear by last Thursday’s initial jobless claims figure in the USA. At the height of the economic pain of the global financial crisis (March 27, 2009) the jobless number hit 665,000. Last week’s figure was ten times that.

With the number of coronavirus deaths per capita, per day, in the US now higher than during the US Civil War, the pressure on the US economy and its healthcare system will grow. The same will be true of many other countries, and though part-time or partial work schemes in economies like France and Germany may lessen the economic uncertainty, it will still weigh heavily. For instance, the past week has already seen food shortages in Italy, mile long queues for food banks in Pennsylvania. In many cases, loans, compensation and government payouts in the US will not arrive in bank accounts for weeks.  

As this urgent, difficult stage of the coronavirus crisis develops, obligations on governments will grow. In Europe, there is an opportunity for what we might stereotypically call the ‘Northern’ countries to repair the diplomatic damage to the idea of EU solidarity of recent weeks (I am thinking of the Dutch in particular!) and undertake to ensure that food and basic staples can reach parts of the EU where they are needed.

In the USA, the past three years have seen a hollowing out of expertise in government. Consider that in 2017 and 2019 the Pentagon and White House economists respectively developed studies to plan for a coronavirus like pandemic, but the executive did very little to prepare for such an eventuality. In the longer-run, the state of healthcare and the fragility of the US labour market should become major political issues. In the meantime, I expect that both corporate America and the military will play a greater logistical role in meeting the needs of this next phase of the crisis in the US.

As this occurs, the debate on the marginal usefulness of the lockdown (in terms of its contribution to lives saved versus its economic impact) will grow. It has already been marked by what I call the ‘cure is worse than the problem itself’ brigade.

Two more weeks of lockdown in Europe will test the sanity of its citizens (though will I hope also show the value of this strategy) and business people. At very least, political leaders will have to outline some kind of roadmap to normalisation – the continued isolation of vulnerable members of society, wearing of masks, a gradual return to normal working patterns for example. Balancing this will be incredibly hard to do, and control. At this point, market volatility may give way to a pick-up in social and political volatility.

Have a great week ahead,

Mike

Why did nobody notice it?

Not amused

During a visit to the London School of Economics in November 2008 Queen Elizabeth II demanded about the debt bubble, “Why did nobody notice it?”. She might ask the same about the onset of the coronavirus crisis, particularly of her prime minister and her eldest son. The defining characteristic of the coronavirus crisis has been its speed. For example, markets have fallen by the same magnitude as during the dot.com crisis, but this time the fall took 16 days not 16 months.

The speed is explained by the sudden restriction placed on human movement by the crisis, and the fact that in general we are used to dealing with single set piece economic or financial crises (market bubble, classic recession, regional – EM or EU – crisis) and not five overlapping crises at the same time. The speed and drama of the crisis is heightened by the fact that it is breaking things – diplomatic relations, investment funds, political careers and economies.

The policy response has not, as I have outlined in previous mails – been well coordinated between fiscal and monetary policy, nor between nations. That so many policy makers repeat Mario Draghi’s mantra of  ‘do whatever it takes’, betrays the fact that the magic of those words is vested in Draghi himself.

Still monetary and fiscal support has come thick and fast and will help stem market pain. My worry is that given we are at the late stage in a very long expansion, it will be harder for policy to significantly boost trend economic growth. Of the other policy measures – the quest for vaccines and treatments is the most exciting, whilst Russia and Saudi Arabia’s adherence to their oil price war is the most disappointing.

From here, I see three scenarios.

Easter: Under this optimistic case (25% likely) the fruits of isolation in Europe begin to show, the race for treatments and vaccines is promising, while central bank liquidity dampens market distress. As such, workers, companies and governments begin to get a sense as to the parameters around the crisis and some visibility as to when and how it can be managed. A slow return to ‘normal’ then begins in Europe and the US in late April. Stock markets hit new highs in October and Donald Trump stays in the White House.

Summer: ‘Isolation’ is increasingly debated on ethical, economic and political grounds. It proves hard to enforce across America and harder still to prosecute in emerging economies. Under this ‘main’ scenario (55%) the second derivative in infections and macroeconomic indicators only begins to significantly improve in mid-summer. As a result, many businesses close or are near to ‘broken’, despite fiscal support. At the same time, investment in ‘newer’ industries – data (5G, AI, Cloud), healthtech and digital finance is accelerated. Still, high unemployment and low trend growth are significant policy issues into 2021.

Winter: Under this ‘pessimistic’ (20%) scenario, much of the world’s workforce is disrupted by the virus, and second waves become the norm. Social unrest, political disunity and a breakdown in diplomacy between nations (US and China for instance) are some of the resulting side-effects. Monetary and fiscal policies cannot contain the full effects of bankruptcies and unemployment, to the extent that central banking ‘accidents’ crop up. The 1930’s is the nasty template to follow here. Property markets and alternative asset classes like private equity are hard hit.

While broad scenarios are useful for framing problems, they are often overly simplistic. One distinction to draw here is between the short to medium term return to normal in terms of end of isolation and return to work, and the enduring long-term imbalances that result from, and are exacerbated by this crisis.

Ideally, following a two-month period of isolation in the US (taking us to mid-May) a return to normal might be in sight.

However, under the surface of the world economy the following trends will have been deepened by the crisis – the end of globalization and the resulting multipolar world, the biggest debt load since the Napoleonic Wars and central banks who are running out of effective policy measures. In the alphabet soup of U, V,L and W shaped recoveries that forecasters talk about, we might well have a cyclical V, followed by a structural L.

With three of the G7 leaders now in quarantine, world political leadership is under strain. It has two battles to fight – beating the virus, and then resolving the end of globalization in as constructive and imaginative a way possible.

With best wishes

Mike

Quid Pro Quo

No Quid Pro Quo?

Otto von Bismarck, 19th century Germany’s Iron Chancellor, is reputed to have said ‘laws are like sausages, it is better not to see them being made’. With the benefit of very recent experience, the same is true of economic and monetary policy. The lightning speed with which a public health crisis has morphed into a deep, financial crisis has resulted in chaotic policy brawl where bouts of market volatility are met with new initiatives.

There is little sign yet of coordination across nations and regions, and between monetary and fiscal policy authorities. The US, Europe and China are all guilty here. In the short-run, the flow of policy moves will likely eventually swamp market volatility. Policy makers, be it in the Treasury, White House or the Fed may sigh with relief when volatility dies down, but they will do well to focus on the potential of their actions.

While the speed with which the coronavirus has morphed into a deep financial crisis has humbled policy makers, it has also revealed the faultlines in a deglobalizing world.

For instance, world debt to GDP is the highest since the second world war, labour markets have been hollowing out, and instead of investing in capital spending many American companies have deployed cashflow to buyback shares (Boeing, which has spent tens of billions of dollars on stock buybacks and is now seeking a bailout of sorts is an example).

The relevance of share buybacks here is that they have pushed up earnings per share, the choice benchmark for CEO pay.  So, with two-thirds of CEO’s being paid according to rising earnings per share, playing a ‘financial’ trade rather than say making better products (e.g.  Boeing) has been attractive for executives.

Yet, having debated ‘stakeholder capitalism’ at Davos in January, the corporate world is now entrenched in ‘survivor capitalism’. The risk now is that in treating the fallout from these faultlines, that has been catalyzed by the coronavirus crisis, policy makers paper over bad economic behavior that has contributed to unimpressive productivity over the past decade, and growing wealth inequality.

In this context, policy action needs to have a ‘quid pro quo’. The phrase entered the lexicon of American politics through George H Bush, and more recently in the President’s impeachment case. The notion of a quid pro quo should reign over policy interventions, in potentially, a range of ways that will produce a more sustainable and resilient economic model.

A first suggestion is that though the USA has no corporate governance framework in the same way that the UK does, a ‘quid pro quo’ skeleton framework can be introduced in return for policy support. For instance, it should tie executive pay more closely to underlying profitability and an array of measurable goals, rather than earnings per share. Tax and securities laws can make overly enthusiastic share buybacks and excessive debt loading less attractive.

Second, many businesses that will require assistance – such as airlines and energy companies – are vital cogs of the economy but also contribute to climate damage. One brief upshot of the now worldwide coronavirus quarantine is that the skies over China have cleared of pollution and the waters of Venice have a healthier hue.

Here, financial assistance to companies should come with the rider that as a quid pro quo they change business models to become more environmentally friendly – that can entail more investment in green sources of power and raw material, less investment in extractive industries and an acceleration in the adoption of a ‘green’ approach to urban develop.

Then, while medical studies suggest that the human cost of the coronavirus can be severe – one scenario in an Imperial College London study points to over 2 million coronavirus related deaths in the US – the coronavirus crisis, like the global financial crisis, has laid bare the vulnerabilities of American society.

At a time when life expectancy in the US has been falling and where healthcare is a locus of inequality, and when tens of millions of workers are vulnerable to layoffs, this crisis presents an opportunity to rethink the US healthcare model and to fashion a more resilient labour market. If this is not done now, there will be a severe political backlash.

The idea of a ‘quid pro quo’ is to encourage policy makers to stop and think about the faultlines that the coronavirus has exposed, to mend them and to steer industries and society towards a more sustainable path.

Otto von Bismarck also said that ‘politics is the art of the possible’, now is the time for policy makers to grasp this by matching urgency with foresight.

Have a great week ahead,

Mike

Friday 13

Lagarde, Merkel

In the current panicked environment, it will not have escaped the attention of most people that last Friday fell on the 13th of the month. Friday 13th is typically seen as an omen of dark things to come, though its origin is more interesting than many will suspect.

Friday 13th October (1307) was the day that King Philip (le Bel) IV of France launched a lightening raid against the Knights Templar, imprisoning their Grand Master Jacques de Molay and many others. Philip was in debt to the Templars, whom he also feared for their military power and the clout of their pan-European financial network (they in many respects, invented banking as we know it).

The Templars were subjected to years of torture, the techniques of which prefigure the worst of the Inquisition and recent wars (i.e. water boarding). At the end of some seven years in captivity, Jacques de Molay was arraigned, and upon declaring that his only mistake was to renounce the Templars, he was carted off to be burnt at the stake (there is a memorial to him at the end of Ile de la Cité in Paris). Before dying, he cursed Philip and the Pope, both of whom died within the year.

While this tale is a good diversion from the ups and downs of the Dow, and to scare you the death of de Molay was followed thirty years later by the bubonic plague, it has made me think of the the link between torture/pain and one’s view of the world.

In de Molay’s day, torture quickly made the Templars recant their views, and in markets the same is true today. My first thought is of ECB President Christine Lagarde, who having been born in Paris should be familiar with the plight of the Templars.

On Thursday she stepped into the fire of markets by declaring that it was not the job of the ECB to close bond spreads. It was a brave statement, delivered at exactly the wrong time. Regular readers will know that I often rail against the ‘morphine’ that central banks have provided to economies and markets, and of the need to curb the oversized role of central banks. Lagarde, wisely I think, agrees and she has also expressed the view that European governments (especially Germany) need to be much more fiscally active.

By choosing to express this near heretical view, Lagarde risked monetary martyrdom, and disarray on the periphery of the European bond markets. I suspect that the pronounced and prolonged market volatility will produce a more generous and less thoughtful policy response from the ECB. We should expect a rate cut, more QE and liquidity intervention and I suspect more joint communiques with the Federal Reserve.

Lagarde is not alone in having her feet held to the fire of the market’s ire, Angela Merkel may be next. If there is a time for Germany to engage its borrowing power and fiscal surplus, it is now. Berlin needs to quickly communicate a plan to stimulate the German and by extension the European economy. This must also include ambitious structural objectives such as the need to a unified pan-European capital market, banking consolidation and a common approach to business start-ups across the EU.

If Merkel doesn’t act now, her career will be marked by banking collapses and rising unemployment. Like the network of the Templars, the future of the Union is at stake.

In the same way, the future of Donald Trump and the American approach to capitalism is also at stake. His administration is not the exemplar of the kind of big, responsive and diligent government that is necessary to defeat this crisis. Neither is big, responsive and diligent government something that can be conjured up in the short-run.

As market pain persists, I suspect that the Trump administration will increasingly turn ‘socialist’, and ask the private sector to take the strain of the coronavirus crisis (i.e. organizing testing, work from home and a less aggressive approach to layoffs), and will push for new monetary measures such as ‘helicopter money’ from the Federal Reserve. As the unfortunate Jacques de Molay found, pain can motivate great inventiveness.

Have a great week ahead,

Mike

Recession Rehearsal

Powell troubled by low rates

The last week has seen many different expressions of adaptive behaviour. First, the Democratic Party establishment and organisation have rallied around Joe Biden, and helped to push him to stunning turnaround in the Party’s campaign for President.

Then there has been widespread adaptation to the coronavirus – people have stopped shaking hands, travel only when necessary and it seems, lead incrementally more healthy lives (though a half-marathon I had entered was cancelled). In some cases however, stoicism wins out – the London Tube is as packed as ever.

In markets, investors – a great deal of whom are unsentimental robots – are adapting to extreme volatility. It has been one of the most extraordinary weeks in markets as investors try to position around the uncertainties introduced by the coronavirus. If and when we get it, a mid-twenties reading on the Vix volatility index would suggest that what might be described as ‘normal’ trading is getting underway. 

Then, policy makers have also been adapting, slowly. My sense is that to a large extent the policy reaction to the coronavirus is a rehearsal for how the next recession is met. So far, it has been a shambles. 

Jerome Powell, in making a 50 basis point cut in interest rates revealed that he is beholden to both equity and bond markets, and it seems, to politics. His action underlined the existence of the Fed ‘put’ – that the central bank will ride to the market’s rescue in times of turbulence.

The delivery of the rate cut was poor.  It focused insufficiently on the sense that this move would provide ‘insurance’ and on the ways it might combat the economic panic (e.g. risk of bankruptcies) associated with the coronavirus.

With the idea of a ‘rehearsal’ in mind, Powell’s move contributed to a feeling that when the ‘real’ recession comes, the Fed will have relatively little monetary ammunition and may, like the ECB and Bank of Japan (BoJ), have to resort to extraordinary measures like negative interest rates. 

If that is where the Fed is headed to, then the lesson for them from the likes of the BoJ, ECB and Riksbank in Sweden is not a happy one. The rush towards very low to negative rates in those monetary jurisdictions undercut banking sectors – a key reason why Europe and Japan have had weak recoveries, and also why to date US banks have outcompeted their international rivals. Sharply cutting rates, in tandem with a compressing yield curve, undercuts the balance sheets of banks, and in some cases can deepen a downturn. The Fed needs to study this carefully.

The second issue with the political response to the economic side-effects of the coronavirus crisis so far, is that despite G7 conference call and very general statement of intent, there is little apparent leadership and coordination.

The fracturing of international politics has made sincere collaboration difficult in practice (America might for example have announced a moratorium on sanctions on China). Moreover, the absence of a serious fiscal response in countries like Italy (the support measures announced come to only 0.3% of GDP), and the notable lack of open thinking on how deregulation might serve to boost business, is worrying.

I may be a little too critical here, but the sum of the week’s policy activity highlights depleted economic arsenals. Debt is too high and few countries have a decent fiscal surplus. Those that do, like Germany, don’t have the will to spend it.

It also points to a depleted international policy community – where the goodwill, leadership and force of mind that existed in the 1980’s or 1990’s (I am thinking of the likes of James Baker or Robert Rubin) is no longer visible. In Europe, Christine Lagarde has been strangely quiet.

There is now a need, an opportunity and hopefully time for someone like Kristalina Georgieva, or even departing Bank of England boss Mark Carney, to so a postmortem on the economic policy response to the coronavirus crisis. With world debt to GDP at its highest level since the Second World War, the next recession will be for real.

Recession rehearsal

Powell under pressure

The last week has seen many different expressions of adaptive behaviour. First, the Democratic Party establishment and organisation have rallied around Joe Biden, and helped to push him to stunning turnaround in the Party’s campaign for President.

Then there has been widespread adaptation to the coronavirus – people have stopped shaking hands, travel only when necessary and it seems, lead incrementally more healthy lives (though a half-marathon I had entered was cancelled). In some cases however, stoicism wins out – the London Tube is as packed as ever.

In markets, investors – a great deal of whom are unsentimental robots – are adapting to extreme volatility. It has been one of the most extraordinary weeks in markets as investors try to position around the uncertainties introduced by the coronavirus. If and when we get it, a mid-twenties reading on the Vix volatility index would suggest that what might be described as ‘normal’ trading is getting underway. 

Then, policy makers have also been adapting, slowly. My sense is that to a large extent the policy reaction to the coronavirus is a rehearsal for how the next recession is met. So far, it has been a shambles. 

Jerome Powell, in making a 50 basis point cut in interest rates revealed that he is beholden to both equity and bond markets, and it seems, to politics. His action underlined the existence of the Fed ‘put’ – that the central bank will ride to the market’s rescue in times of turbulence.

The delivery of the rate cut was poor.  It focused insufficiently on the sense that this move would provide ‘insurance’ and on the ways it might combat the economic panic (e.g. risk of bankruptcies) associated with the coronavirus.

With the idea of a ‘rehearsal’ in mind, Powell’s move contributed to a feeling that when the ‘real’ recession comes, the Fed will have relatively little monetary ammunition and may, like the ECB and Bank of Japan (BoJ), have to resort to extraordinary measures like negative interest rates. 

If that is where the Fed is headed to, then the lesson for them from the likes of the BoJ, ECB and Riksbank in Sweden is not a happy one. The rush towards very low to negative rates in those monetary jurisdictions undercut banking sectors – a key reason why Europe and Japan have had weak recoveries, and also why to date US banks have outcompeted their international rivals. Sharply cutting rates, in tandem with a compressing yield curve, undercuts the balance sheets of banks, and in some cases can deepen a downturn. The Fed needs to study this carefully.

The second issue with the political response to the economic side-effects of the coronavirus crisis so far, is that despite G7 conference call and very general statement of intent, there is little apparent leadership and coordination.

The fracturing of international politics has made sincere collaboration difficult in practice (America might for example have announced a moratorium on sanctions on China). Moreover, the absence of a serious fiscal response in countries like Italy (the support measures announced come to only 0.3% of GDP), and the notable lack of open thinking on how deregulation might serve to boost business, is worrying.

I may be a little too critical here, but the sum of the week’s policy activity highlights depleted economic arsenals. Debt is too high and few countries have a decent fiscal surplus. Those that do, like Germany, don’t have the will to spend it.

It also points to a depleted international policy community – where the goodwill, leadership and force of mind that existed in the 1980’s or 1990’s (I am thinking of the likes of James Baker or Robert Rubin) is no longer visible. In Europe, Christine Lagarde has been strangely quiet.

There is now a need, an opportunity and hopefully time for someone like Kristalina Georgieva, or even departing Bank of England boss Mark Carney, to so a postmortem on the economic policy response to the coronavirus crisis. With world debt to GDP at its highest level since the Second World War, the next recession will be for real.

Globalization crashes

Coronavirus has spread internationally

That a rugby match in Dublin between Italy and Ireland can be cancelled because of a virus that germinated in a market in a Chinese city, may be a chain of events that appeals to amateur chaos theorists.

In my view, the panic caused by the coronavirus illustrates how easily interconnected the world has become, how fluidly people move from one location to another, and how national infrastructure and policy systems are still so very different.

Having written about the coronavirus a few weeks ago (‘Humanity and Adversity’, Feb 2, https://thelevelling.blog/2020/02/02/humanity-and-adversity/) I thought that markets at least would quickly work through the implications. That it has not been the case owes much to another form of sickness – overexuberance in financial marketplace. The catalysts provided by the coronavirus are now treating this (in the short run the sell-off is nearly complete, and we will rally mid next week).

Ironically, in an age of machines, and where social media companies are dominant in many senses, markets are responding to the risk that humans will have less physical interaction with each other and will enjoy less physical forms of consumption (travel, shopping and consumption).

As I write, it appears at least from official numbers that the virus is somewhat contained in China, and globally the number of cases looks to have peaked. Here though, the risk is that the Chinese authorities rush people back to work and, like the Spanish flu in 1918, there is a bigger second (and third) wave of the virus.

The passage of the virus across the world has, even at what might be an early stage, revealed and further provoked a number of changes in our world.

The first relates to trust. There is widespread suspicion inside and beyond China that the authorities there have not been upfront about the true extent of the virus. Some, like US Senator Tom Cotton even believe that the virus is man-made. To that end, while China’s handling of the crisis will on one hand reinforce the sense that it can marshal huge swathes of its population, on the other the trust of outsiders in the Chinese authorities will diminish. The Belt and Road Initiative may be a casualty here. Distrust can also channel itself in other ways. If in the future China has a debt crisis, investors are likely to sell first than wait for a true picture to emerge.

Within China this episode has clearly damaged the Communist Party, though it is very hard to see how this will play out in public life, or even through social media discourse. My sense is that the Chinese authorities will react in at least two ways. One is a fiscal stimulus made up of tax breaks, support for small businesses and an acceleration of infrastructure programs.

The other more interesting one is to take what has been done in the domain of social control and social credit scoring and apply this to healthcare. I can envisage a sharp rise in self-diagnosis, tech based medicine and a related set of incentives for people to allow their health data be monitored by the state. If it happens, many in the West would consider it insidious, though given the fear created by the virus, many Chinese might acquiesce.

The second effect of the coronavirus crisis is that it is yet another event that makes visible the arteries of globalization and leaves them atrophied. That there has been little to no coordination between nations speaks to a sense of a fractured world, and the performance of the WHO reinforces the view that like the WTO, its time has come.

There will be a sharp short-term hit to world trade from the coronavirus (hotels, airlines are the obvious ‘victim’ industries though I think that ‘elite’ forms of travel and healthcare will continue to thrive), but in the longer-term it will also reinforce the sense in governments and some companies that security of production is increasingly important.

To that end, the rise of national champions and the relocation of production to ‘home’ countries (pharmaceuticals is an example) will continue. In many different ways, the coronavirus, like the 2019 trade war, will force a rethinking of globalization by corporates.

Other megatrends may also be rethought. India and many parts of Africa are the only parts of the world where urbanization rates are still relatively low, though where the rate of urbanization is now picking up. The coronavirus crisis is a very clear reminder of ‘smart’ urbanization is terms of the health, data gathering and communication implications, and in this way the lessons for Wuhan are yet to be learnt. For example, it is only emerging that 40% of the coronavirus cases in Wuhan were transmitted in hospitals – and the same may be true of both Italy and Iran. 

As this adjustment process happens, there will likely be one constant, which is the vogue of central banks to meet any threat to growth and attendant dip in markets with more liquidity. Liquidity provision and rate cuts will not solve the process of adjustment away from globalization, and in the long run they may channel this process down the wrong path because cheap money increases the risk that investment decisions are badly made.

Have a great week ahead,

Mike

Exorbitant privilege endures

Strong then, strong now

Whenever the dollar strengthens noticeably (and it has just risen to a three year high against the trade weighted basket of other major currencies) commentators usually dust off a quote from former US Treasury Secretary John Connally who, when discussing the strong dollar with visiting German politicians in 1971, said ‘its our currency, but your problem’.

Connally had an interesting career – he was seriously injured in the assassination of John Kennedy and he was responsible for breaking the link between the dollar and gold.

In his remarks to the Germans he most likely had in mind the privileged role of the dollar as the world’s reserve currency, and the reality that America’s trading partners had simply to suffer this ‘exorbitant privilege’ as Giscard D’Estaing put it.

In the context of the trade war, and America’s more singular approach to diplomacy, the recent surge in dollar strength deserves some analysis.

Since the time of Connally – the passage of globalization, the emergence of the euro and the economic rise of China – to today, the dollar has been unassailed as the world’s reserve currency.  With 63% of all of the world’s trade settled in dollars, and similarly about two thirds of all the world’s debt denominated in dollars, the US is arguably far, far more powerful financially than it is militarily.

More importantly, as other sources of American power are diminishing – human development is falling, soft or diplomatic power is in recession, China is catching up in naval, missile and drone military capabilities – the dollar is America’s one remaining source of utter dominance.

One very interesting original, approach to examining the durability of dollar strength comes from Professor Barry Eichengreen, the academic authority on currencies. In a paper entitled “Mars or Mercury? The Geopolitics of International Currency Choice” written Eichengreen and with two economists at the Euro- pean Central Bank (ECB) describes two approaches to valuing currencies.

First, there is the more conventional “Mercury” approach, which gauges currency strength by analyzing variables like interest rates and currency reserves. The second approach, “Mars,” sees a currency as reflecting the standing of a country in the world—the quality of its institutions and its alliances.

Using data going back to the First World War, the paper finds that military and geopolitical alliances are a significant factor in explaining currency strength. The rationale is that a country that is geopolitically well placed is engaged with and trusted by its allies through trade and finance.

Eichengreen and his coauthors have set up a framework to capture the impact on the dollar of US diplomatic disengagement with the world. One of the main implications the “Mars or Mercury?” paper finds is that, in a scenario where the United States withdraws from the world and becomes more isolationist, its strategic allies no longer become enthusiastic buyers of US financial assets and long-term interest rates in the United States could rise by up to 1 percent because there would be fewer buyers of American government debt.

At a strategic level, what is interesting is that despite the chaos being wrought on US diplomacy and America’s diplomatic relationships – Latin America is forgotten, Europe chastised and Asia provoked – there is no sign yet that Eichengreen’s thesis is playing out. Perhaps it is too early to tell.

Perhaps it also has something to do with the fact that much of the rest of the world economy is stagnant – recent data point to the fact that Japan may be in recession and some large European economies are flirting with it. This, and the overeager activism of the Fed make dollar denominated assets attractive keeps the dollar bid. At the same time this draws capital out of emerging economies, a trend manifest in the weakness of emerging market currencies.

In the long run, there are maybe four factors to watch that could make inroads into the dollar’s dominance of finance.

The first two will only become evidence in the aftermath of the next recession, whenever that is. One is the ability of the euro-zone to prove that its financial system can stand up to another downturn (in many ways it is less indebted than the US and China) and grow its economy.

The other, is similarly the financial shape China finds itself in after a period of negative growth, and the kind of steps it takes to build out its financial markets (such as deepening of its bond market and developing its pension system). If it can do so in a way that encourages liquidity and transparency then the share of Chinese assets in international (and Chinese) portfolios will rise significantly, drawing capital out of the dollar.

There are two other wildcards. Should the US continue to disenchant its allies, neighbours and trading partners then the Eichengreen hypothesis will play out, with the Middle East, India and parts of Latin America prone to diversify their currency reserves.  

Then finally, the prospect that central banks may someday introduce digital currencies. This may shake up financial flows, central bank reserves and economic structures, and in turn, might shake the dollar. But, not yet.

Have a great week ahead,

Mike

Will the political recovery be U, V or L shaped?

Collecting votes in Ireland

The term ‘paradigm shift, rather like ‘black swan’, is often misused and overemployed. However, the increasingly fractured world order is beginning to throw up more and more examples of genuine paradigm shifts, such as the result of the recent Irish election and the turmoil at the heart of German politics.

Both correspond to the broad terms of a paradigm shift – the crumbling of a long-established order, a fallow interregnum marked by disorder and questioning, followed by the making of a new way of doing things.

In the case of Ireland, the aftershock of its financial crisis has seen Fianna Fail slip from a period of multi-decade political dominance, Fine Gael’s failure to supplant Fianna Fail, the rise of many independent TD’s (members of the Dáil, the Irish parliament) and new parties, and now the sudden rise of Sinn Fein. When the dust settles, the Irish political spectrum will likely follow more traditional lines, Sinn Fein leading the left, Fine Gael to the right with Fianna Fail disintegrating towards both the left and right.

In Germany, Angela Merkel’s decision to welcome over a million refugees into Germany was her ‘poll tax’ moment, and this set in train the rupture with the stability that stretched back to Helmut Kohl. German politics is now in the disordered interregnum, where parties of the centre are trying to adjust to new issues (climate change, immigration, geopolitical shift), as those of the fringe attack the old consensus. The easy populist solution would before a centrist politician to spend some of Germany’s budget surplus, though this may not resolve the identity crisis in German politics and society.

The cases of Ireland and Germany can be added to a heap of plausible examples of paradigm shift – Brexit and Trump obviously, the role of central banks in markets and the impact of technology on our lives. As such, many people no longer push back on the idea that we live in a ‘world upside down’.

To come back to politics, US academic Larry Diamond has written of a democratic ‘recession’, and political theorists might, as economists did then years ago, debate whether the political recovery will be U, V and L shaped.

In that respect, what is of interest for politicians in Ireland, Germany and the likes of Spain, is to see how other ‘paradigm shifts’ are evolving.

In Europe, Emmanuel Macron’s playbook (perhaps I should say ‘stratégie’ or Grand Plan) has been to capture and hold the political centre, which in my view makes a great deal of sense. He has also aligned the apparatus of state, in that most institutions willingly work to his agenda (the same would not be true if say Jeremy Corbyn had become British Prime Minster). Given the economic and political tasks he is taking on in France and Europe respectively, his performance is easy to criticize, and many take advantage (as the Griveaux incident shows).

Viewed from Cork or Dublin though, he has two blindspots. One is to make the style of government more human and grass roots driven. The other is to take credit for the sharp fall in French unemployment. If unemployment in France falls below 7% by the end of this year it will have a wholly underestimated, positive effect on state finances, on ‘happiness’, human development and on the integration of immigrants. Macron should acclaim this achievement more.

One politician who would not be shy of doing so is Donald Trump, who while not consciously holding the centre, is using the prospect of rising financial wealth, a strong economy and his willingness to harry economic competitors as an inducement to Americans to tolerate ‘four more years’. Unless the Democrats can reverse the shift to the left that most of their candidates have taken, they risk being perceived to demand that middle America commits to an uncertain economic future.

This sense of the unknown was what finished Labour in the UK. However, instead of cementing his political capital at the centre of UK politics, Boris Johnson, by shedding the services of so many capable Tory MP’s and ministers (Julian Smith the former Northern Ireland Secretary was voted politician of the year by the Spectator) is drifting towards the touchline of British politics.

A person to person comparison with say the macron government, or even with the cabinets of John Major and Tony Blair, shows the new Johnson cabinet in a poor light. This makes me think that the paradigm shift in UK politics is by no means over. The centre is being deserted and there is an opportunity for Labour, or more likely in my view, a new party, to fill it.

Have a great week ahead,

Mike

Technopolitics

Technology meets politics

About twelve years ago, I accompanied an American friend to a Democratic Party fundraising event in London. The main speaker at the event was Michelle Obama, and once she had delivered her eloquent and rousing address, I was tempted to think that the Democrats had opted for the wrong Obama.

Michele Obama might yet have her chance to run for president. There are rumours that in the wake of the technological fiasco of the Democratic primary in Iowa, and the failure of a clear Democratic leadership candidate to emerge, the Democrats may opt to choose someone with the brand recognition of Michelle Obama.

This is yet a wild-card scenario, though it does underline the meshing of politics and celebrity, and in the case of Iowa, the complications that technology is introducing to politics.

In common with many companies, a political party’s ability to use social media is now one of the defining metrics of its success (in much the same way that radio impacted politics in the 1920’s and tv did so from the 1960’s onwards).

The Arab Spring was the first event to demonstrate the power of social media in political activism. Donald Trump’s campaign team used social media to great effect in 2016, as did Dominic Cumming’s Brexit referendum campaign, from which he excluded MP’s and instead loaded up on data scientists.

Having written on the Chinese Communist Party last week (‘Humanity and Adversity’), one social media news story to keep an eye on is the reaction across China to the death of Li Wenliang, the doctor who courageously warned of the virus in late December. Sympathy for him and anger at attempts to suppress his warnings may be the making of an unexpected but powerful backlash against the CCP.  

More broadly, as social media has permeated mainstream politics, its effects have become much less unambiguously positive. In some respects they have amplified extreme views. For instance, in the European Parliament, the two groups at the respective left- and right-wing extremes have close to 12 percent of seats but over 40 percent of Twitter followers. In this way, social media is excellent for mobilizing voters, though perhaps less so in representing them.

Social media is having a more profound impact on policy making. It raises the tempo of politics such that political decisions end up being made too quickly and sometimes on Twitter.

Another issue at the intersection of politics and technology is simply ‘truth’ or fake news. I won’t rehash the debate on the verifiability of the claims of more populist politicians, but will remark that bad ideas seem to travel faster and further than good ideas (this is the fault of humans and not robots).

There is however another, positive side to the impingement of social media on democracy that I want to highlight, partly because I had not suspected it existed (through my own ignorance) and because I have lately stumbled upon it.

One of the topics in ‘The Levelling’ is the idea of a modern ‘Agreement of the People’, a template that would express what people wanted from politics in concrete terms. I had hoped, and still do, to harness social media to produce a ‘mass’ version of this. In my efforts to do this I have come across a range of projects that I can recommend readers dig into, if only to give them faith that social media can play a constructive role in politics.

The most significant project I have come across is the NYU Governance Lab (Govlab) where they pursue approaches such as ‘crowdlaw’ that captures the power of crowd thinking to improve the quality of lawmaking, or the use of social media in improving trust in public institutions, or the use of data and social media to enable city managers solve urban problems (something that will become a science of its own with the advent of 5G telecoms technology).

Another port of call is the Oxford Internet Institute, where there is a great deal of work for instance on the role of online petitioning for social and political causes, and also on the design of direct democracy apps for use in German cities. I will let readers delve into the web sites of these and other (MIT is another) institutions, as there are two further political/social media trends worth watching.

The first is the extent to which politicians either try to coopt large social media and data intensive companies, or to heavily restrict their reach, at least as politics is concerned. The move in some countries to treat social media content as if it were equivalent to newspaper content (this would make social media companies liable for the views expressed on their platforms), is part of this trend, and there will surely be more debate on the need to break up large social media/internet driven companies – at least in the West.

The other intriguing possibility is the entry of technology to politics as a political issue or cause. To date there are very few parties who have a prominent, well thought out policy on social media in the sense of how it impacts our lives.

I expect this to change and can imagine that in the future we might see political party that is driven by the role of technology in our lives, it could be called the ‘Governance Party’ – it wants to use block- chain in health-care and social welfare systems, it preaches that technology should not be feared and should be actively used by government, it believes in codes of conduct in public life, society, and business and that these can be overseen through technology,  citizenry is closely tied to electronic-based identity systems so that nearly all forms of behavior—consumption, voting, contribution to pension plans, to name a few—can be monitored and optimized.  

To many this will sound alarming, but such ideas are being embraced in countries like Estonia, Romania and China. It makes Iowa look rather tame though.

Have a great week ahead,

Mike