When central banks fall down, they often call other central bankers to help out. The Riksbank asked Mervyn King, governor of the Bank of England up to 2013, to examine its forecasting ability over the course of the 2010’. More recently, the Bank of England whose own forecasting went askance (nothing to do with the practices instilled by Mervyn King of course), asked former Fed chair and Princeton professor Ben Bernanke to cast an eye over its methods.

Bernanke delivered his report a year ago, where his broad conclusion was that central banks in general had performed poorly at macroeconomic forecasting, chiefly because of the series of large global shocks the world has experienced (and I would add the resulting ‘shock and awe’ response of central banks). In the specific case of the Bank of England, Bernanke painted an unflattering picture of a fusty institution where software systems are embarrassingly outdated, data sets are poor and staff resources are badly managed.

One clever solution to all this might simply be, in this age of AI, to ask ChatGPT to forecast growth and inflation. I did so, and it told me to ask the Bank of England.

In fact, central banks are already using what is popularly known as AI. Some central banks in emerging nations like Indonesia use it to scan the public reaction to their monetary policy, and many economists have been using machine learning and probabilistic models well before AI became popular. Indeed, there is growing thought leadership on the use of AI in central banking by bodies like the Bank for International Settlements (BIS).

In some fields, central banks use AI to help oversee the supervision of financial institutions. The ECB has launched the Athena project, which uses AI to help banking supervisors scan millions of documents, so as to help regulators spot anomalies. An extension of this focus is central bank monitoring of fintech firms who themselves use AI to allocate credit and investment strategies to individuals and households.

In the recent past I have referred to the growth of this segment of the banking industry, especially that over one third of ‘unicorn’ level companies in the UK are fintechs and many of these are involved in AI driven lending.  This raises many challenges for supervisors, not simply the difficulty of grappling with new datasets (and their provenance) but also in terms of trying to understand the construction of the AI models that drive fintech services.

In the context of the finalisation of the EU AI Act this year, the use of AI in finance is one of the areas where central banks and supervisors have some catching up to do. Imagine when stock exchanges and certain institutions start to use quantum computing in trading and research.

To my knowledge, the use of AI in central banking seems to be grounded in the assumption that AI driven outcomes are produced to aid, but not replace, the economist/supervisor. I call this the ‘One Man and his Dog’ approach, where the human is assisted in a complex task by a clever, adaptive non-human actor (it used to be a dog but now it’s a computer). It would be a mistake for central bankers to take a more machine centric approach. However, a few obstacles remain.

To tally with Prof Bernanke’s verdict on the Bank of England, IT systems at central banks and data management capabilities are behind the best in the private sector, and the market for intellectual labour is in a bubble as far as AI relevant skillsets are concerned. As a result, language model technicians are unlikely to work in central banks – though my own experience is that today the best economists are also very good at modelling and also deploying AI models.

Data is perhaps the biggest hurdle. I came to economics and econometrics at a time when ‘proprietary data sets’ were hand input into excel spreadsheets from corporate accounts, or from clunky Datastream codes. Today the world is awash in datasets that help to explain the behaviour of households and companies – if central banks could be fed this data they would, potentially, be a lot wiser than they are now, though the risk is that they might become too data sensitive.

The temptation then for the next generation of central bankers will be to use the muscle that their supervisory powers give them to obtain high frequency glittering datasets from payment companies, buy now pay later start ups, and option pricing datapools from the institutions they oversee, and clean and analyse these for the benefit of monetary policy and fraud detection. Some central banks, such as the Bank of Canada are active here, but this trend is a developing one. These high frequency datasets can potentially be very interesting in reading economic shocks, and the response of economies to the monetary policy that follows shocks.

There are at least two more considerations.

First, relatively few economic commentators have drawn the link between central bank digital currencies and AI. Central bank digital currencies, if implemented, could generate huge datasets in the financial behaviour of households, which might then be better used to fine tune monetary policy. In an ideal monetary world, central banks would make small, high frequency and economy specific adjustments to policy through their digital currency frameworks (under this every household would have a bank account with the central bank), according to the AI driven models, with a goal of fulfilling their monetary objectives.

Second, central bankers, a fairly conservative though not unsophisticated lot, will have to learn to change their mindsets and communication techniques if they are going to deploy AI to their advantage. That might just be the biggest obstacle.

Have a great week ahead,

Mike 

The last time that Xi Jinping visited France (2019) Emmanuel Macron presented him with a 1688 copy of ‘An Introduction of The Analects of Confucius’. Xi is back in Paris this weekend, his fourth visit, placing France alongside Kazakhstan and South Africa as Xi’s favourite destinations after the US (five visits) and Russia (nine).

As such, the question on my mind is what book Macron should give him this time?

He might start with something on Germany, notably Fritz Stern’s ‘Gold and Iron’ to remind us of what a strong chancellor sounds like (Bismark coined the notion of ‘blood and iron’) and indeed to highlight the link between capital and diplomacy. This is relevant because the first dilemma for Macron is how to steer Olaf Scholz toward a tougher political view on China, given that the German economy remains heavily dependent on China. Macron and Scholz had dinner together (spouses included) in Paris on Thursday.

We don’t know what was discussed – the installation of Mario Draghi as a replacement for Ursula von der Leyen, and Germany paying France to broaden its nuclear deterrent to an EU level – are two possibilities. China’s stance towards Ukraine, its deepening alliance with Russia and the ‘dumping’ of Chinese electric vehicles are topics that were most certainly broached. The mystery is Scholz’ insistence on continuing with a visit to the Baltic states on Monday (6^th May) when he could have accompanied von der Leyen and Macron to greet Xi. It might be that Germany just wants to keep its ‘special’ relationship with China to itself.

Macron might reflect that at least by having von der Leyen there, the case will be made to Xi that visiting Hungary and Serbia, two ‘bad’ actors, at the same time as France is very bad diplomacy by China. It shows that either China is very far away from a cultivated form of soft power, or that it is now so committed to its relationship with Russia that it cares less about what Europe thinks of it.

At the same time, China has lost Italy as a member of the Belt and Road group, and most of the Baltic and Eastern European states regard it with deep suspicion. Macron should dig out a copy of ‘White Eagles over Serbia’ by Lawrence Durrell to make the point that any influence operations out of Serbia will be contested.

If he is feeling imperial (often), Macron might offer Xi a copy of Claude Martin’s ‘La Diplomatie n’est pas un dîner de gala – mémoires d’un ambassadeur’, all 946 pages of which are a reminder of the grandeur of French diplomacy, China’s humble origins and of course how far it has come, spurring demand for French handbags. I should say that, nice caricature as it is, handbags don’t make it into the top ten of French exports to China.

In that respect the substance of the Xi visit will likely be about the ways in which Europe will derisk but not decouple its trade relationship with China. At this point, I suspect that from the point of view of sensitive technologies, much of the de-risking has happened, and that EU-China trade relations are bottoming out (I expect little warmth at the diplomatic level). Both regions will for the time being regard each other as a ‘hedge’ should Donald Trump be re-elected in November and restart a series of trade disputes. Europe does not see China as a close or natural ally, but it may also be useful to preserve civil relations with it lest American politics takes a wrong turn.

To return to the question I mentioned at the top of the note, perhaps the book should be on economics, specifically asset price bubbles and speculation, an original 1841 version of Charles MacKay’s Popular Delusions and the Madness of Crowds’. An even better idea might be some of the original pamphlets (I know where to find them) relating to the scheme of John Law, the Scotsman who blew up the French economy in 1720. It is a tale of financial engineering that few countries have surpassed, with perhaps, the exception of China.

With best for the week ahead

Mike

On Thursday last, Emmanuel Macron gave his second ‘Sorbonne’ speech (the first was in 2017) which consisted of laying out, once again, his vision for Europe, though in a more bleak way, and as it happens, periodically stating ‘I’ve gone on for too long’, and then speaking for another twenty minutes.

I was in London at the time so didn’t have the opportunity to walk up the hill to eavesdrop on the president, but it did remind me of another Sorbonne speech, given some twelve or so years ago by Jack Lang, in honour of the Irish president Michael D Higgins. Jack Lang was called upon at short notice because Jacques Delors was ill, but he nonetheless gave a very credible talk on Irish culture, notably on the work of the playwright Sean O’Casey.

I left the Sorbonne as soon as the speech finished, and so did Lang and serendipitously I had the opportunity to walk back towards the 4^th arrondissement in his company. What I was most struck by was the number of people who stopped Lang in the street, to shake his hand or take a selfie, and I am not sure that there is a French/German or other European politician who would get a similar reaction whilst traipsing across their capital city. The lesson then is that there are votes in culture, but maybe not grand ideas on geopolitics or finance.

To be fair to Macron, he is one of very few European large country leaders capable of setting out a vision for Europe (Stubb and Tusk might also have a go). Some elements of the speech – to make Europe a world leader in spacetech and AI by 2030 are, from my experience, not credible. Similar goals in quantum computing, new forms of energy technology and biotech are.

The real question however, is who is going to pay for it? Is Macron – and Europe for that matter- a Madame Bovary, addicted to fanciful spending with no means to pay for it?

Compared to the US, Europe is much less well equipped to finance these new technologies at scale. Japan and China are also constrained, but China to a large degree can commandeer private industrial capacity.

One early response to the need for Europe to become more dynamic financially was the launching in 2014 of the capital markets union (CMU) which was headlined by the aim of moving corporate financing away from bank lending to deeper capital markets, and the harmonisation of finance regulations so that capital can flow better across the euro-zone.

The capital markets union soon fell by the political wayside (there have been some advances such as the ELTIF – long-term financing product but little has been done to align pension, insolvency and tax frameworks). However, while the likes of Macron are now touting CMU is a necessary part of Europe’s ‘rearming’, EU leaders ducked the chance to accelerate CMU at a summit last week, arguing it would impose greater costs on local asset managers (the reality is that capital markets in those countries – from Ireland to Belgium – continue to shrink).

This is a great disappointment, and it is little surprise then that the overriding tone of Macron’s Sorbonne II speech was urgent. The irony now, given France’s reputation for regulation (the best explainer of this I have read is Augustin Landier and David Thesmar’s ‘Le Grand Méchant Marche) is that it is mostly French officials (Macron, Lagarde, Le Maire) who are pushing for capital markets union. Indeed the former ECB official Christian Noyer has launched a policy initiative in the space.

The sense of urgency should be all the greater when we hear that the US economy (which was the same size as that of Europe before the global financial crisis) is now 70% larger, and that JPMorgan has a market capitalisation as large as the top ten euro-zone banks. America’s ability to fuel innovation and business operations with finance is exceptional, and the failure of governments in many European countries to properly acknowledge this is disappointing.

My suspicion is that the paths of least resistance will be the loosening of investment regulations so that wealthier, professional investors can access segments like infrastructure and private equity, and even more likely (this will also be the case in the UK under Labour) that Europe’s technology infrastructure of the future will have to be funded by private capital, much of it from outside Europe. A halfway house towards realising this objective will be to permit state and semi-private pension funds invest more in private equity (along the lines of the Canadian model)

Doing so might also provoke a radical change in governance, where pension funds have to be more active and where there is greater public representation on boards. It is an experiment worth trying, far more so than the option of forcing pension funds to hold more government bonds, and thus saving the political skin of politicians in indebted countries.

Have a great week ahead,

Mike 

One of the fascinating elements of the post globalization changing world order, which I call the Interregnum, is the way alliances are breaking down (might a Donald Trump led America leave NATO?) and being built up (recall the idea of ‘The Fourth Pole’) as well as being disrupted (Russia’s de facto invasion of central Africa – see The Man on Horseback). The latest example is the fusing of bits of the ‘Quad’ with AUKUS (Australia, UK, US).

In ‘The Levelling’ we had described the Quad as the club of India, Japan, US and Australia, as effectively a bulwark against China’s influence in the South China Sea theatre. The new development, given on one hand India’s diminished credibility and commitment as an unblinking friend of the West, and on the other a renaissance in Japan’s economy and sense of itself on the world stage, is that there is serious talk of Japan being ushered into another geopolitical club (AUKUS).

Given that AUKUS was initially established on the premise of providing new submarines to Australia, and that it is now very unlikely to get these before ‘the next war’, Japan might want to think again.

For my part I have been trying to think of the things Japan has in common with the AUKUS countries (culturally and structurally it arguably has more in common with France). Rugby might be one, but America is not a rugby power, and neither does it have a royal family at the head of the state, though the Trumps might change that.

Appropriately though, given that the Augusta Masters is on this weekend, Japan and the AUKUS countries are all ‘golf states’. Indeed, granted that Russia, Iran and Pakistan are not golfing strongholds, the propensity of a country to play golf, might itself be a geopolitical identifier.

There are close to 40,000 golf courses in the world (according to Golf Monthly) with 16,750 in the US, then Japan second with 3,169, the UK and Canada (this week Justin Trudeau has also spoken warmly of AUKUS) next with over 2,000 courses each, followed by Australia (1,600). Some small countries – notably Sweden and Scotland have more golf courses than China (only 566).

If golf is a marker of Anglo-Saxon and/or bourgeois roots, it is also a tracer for speculation and excess. This week it was reported that the joining fee for luxury golf clubs in Florida has pushed into the millions in some cases, and has tripled in others. This is likely a sign that the local economy in Florida is strong, that the broad wealth effect in the US is robust and potentially that we may be seeing a wealth ‘peak’ in the US.

To bolster this view, consider Japan, whose stock market and property sector are just reaching levels last seen in the early 1990’s (while Tokyo prices have recovered to 1991 levels, the rest of the Japan’s residential market is still below the price point reached then). In the late eighties and early 90’s, Japan was the coming power (Ezra Vogel’s book ‘Japan as Number One’ was emblematic), so much so that Donald Trump went on CNN to castigate American foreign and trade policy on Japan, though he did state in the same interview that he had no designs on the White House.

One of the remarkable socio-economic trends in Japan at the time was the startling rise in Japanese gold club membership fees, which in the heady 1980’s Japan, had become a tradeable asset, so much so that an index was created (always a warning sign). During the period 1982-1989 the average golf club membership fee rose by 400%, with a final 190% spurt from 1989 to 1990. Companies such as Ginza Golf Services initially made a lot of money trading golf club memberships and at the peak of the market some were changing hands for close to USD 3mn.

The rest as they say, is history. In recent years the sport of golf has been in thrall to Saudi Arabia, whose version of ‘luxury’ capitalism has luridly distorted prize money and appearance fees. Interesting then that a couple of years after bidding up golf prize money stakes, the Kingdom is scaling back its ambitions for NEOM and The Line, two futuristic city projects.

It might be too early to tell if the golf curse has struck Saudi, and Florida for that matter, but it confirms a sense that in certain parts of the world the wealth effect is beginning to become disorderly.

The beginning of the week was market by three, similar warnings, each of which add to the drumbeat of alarm over rising debt levels. In France the official government deficit was found to be higher than expected and contributing to a creaking burden of debt, then Larry Fink the head of one of the largest financial institutions warned of the ‘snowballing’ levels of debt accumulation, finally and perhaps most dramatically the Congressional Budget Office in the US has also been highlighting rising debt levels, and in a chart that will likely be repeatedly shared across the media, mapped forward the rising debt to GDP of the US government.

Rising debt is a pre-occupation of mine as many readers know (do listen to Waking up to World Debt). It will be impossible for the world economy to grow at a sustainably high rate until the mountain of debt that the large nations have accumulated is reduced. In recent notes I have started to cover how high debt levels will change politics, and on how indebtedness is part of the equation of great power rivalry.

Several other ‘truths’ are becoming clear.

Nearly fifteen years on from the global financial crisis, it seems that the policy community has largely forgotten the lessons of the crisis. I have re-examined three important books written during and in the aftermath of the crisis (Gary Gorton’s ‘Misunderstanding Financial Crises’, Raghuram Rajan’s ‘Faultlines’ and Mian & Sufi’s ‘House of Debt’), and in general the recommendations and lessons drawn out in those books remain ignored by the policy community. Debt has become an economic way of life. For reference, the UK public debt has gone from GBP 500bn before the financial crisis to GBP 2.6t trn today.

An remarkable facet of the rise of indebtedness is that it is correlated with other ‘crises’. For instance, there is a parallel between the growth of indebtedness and climate damage – average global temperature and indebtedness have grown in tandem (driven by the growth of infrastructure and industry in China in particular), and warnings of impending crises go unnoticed.

One reason for this is the adaptation of the economic system to both climate change and indebtedness, and the fact that policy makers are so far insulated from the consequences of each of these risks – the assumption is that central banks can now control bond market volatility, and so far catastrophic climate events happen ‘only’ in emerging countries.

While a scan of the long-run of economic history, and most finance textbooks would suggest that we should be in the antechamber of a debt crisis, this does not seem to be the case, and the adaptation of the economic system around debt is one reason for this. The prevailing assumption now is that the world economy can operate ‘normally’ in a climate of very high debt levels, and to coin a term we are in an ‘Age of Debt’.

The idea of the ‘Age of Debt’ is something that deserves greater attention, and as a framework it could have several characteristics. Here are a few.

One potentially dangerous trend is the rise of the ‘debt’ industry which is to say the emergence of a decent number of private credit firms in the US in particular, who can lend in a more liberal way than regulated banks.

A corresponding trend is the rise of fintech firms focused on lending (of the Top 100 most promising technology companies in the UK, according to Sifted, over a third are in the fintech sector and a good number of these involve digital lending). The ‘buy now/pay later’ service is a growing feature of many large fintech platforms. Many of these companies will use AI on scraped data and credit histories to decide which consumers are worthy of running up high personal debts.

The rise of the ‘debt industry’ is simply building debt distribution pipelines beyond the banks that have become heavily regulated as a result of the global financial crisis. To an extent they are doing what banks cannot do, and in some cases doing it better than the incumbent banks. To another, they are simply layering more risk onto the financial system.

An interesting element of this, is that the risks associated with rising debt are arguably becoming centred around individual countries. Up to 2007 the global financial system had become interconnected, which is why contagion spread across the international financial system. The global financial system led to enormous deleveraging and retrenchment of banks from overseas markets. This is reinforced by the growth of the ‘debt industry’ as lending focused fintechs and private credit providers are, to my calculations, operating within borders. The upshot of this is to make national financial systems riskier. 

In time, the ability of national financial systems to work through debt will be a marker of the rise and fall of nations in the 21^st century.

Have a great week ahead, Mike

Just two years ago, Germany’s Chancellor Olaf Scholz made a speech in the Bundestag organized around the theme of the ‘Zeitenwende’, which to translate means a period of transition or regime change, or more scientifically a paradigm shift (in geopolitics). It marked a high point in Scholz’ chancellorship. Ever since he has done everything he can to not live up to the challenge of the Zeitenwende, and on my last recent visit to Berlin, I found business people and policy makers despondent.

Germany is not alone in going through its Zeitenwende. Taking an international view, the phrase I increasingly use is ‘Interregnum’, a word inspired by the period between the two King Charles reigns (Charles I was captured in 1647 and then Charles II was ‘restored’ in 1660) when England experimented with a republican democracy.

The Interregnum represented an interruption of the established order of things, and a period of turmoil and some experimentation. Ironically, the initial phase of the 17^th century Interregnum was initially a period of democratic innovation, and aptly, today we enter a geopolitical Interregnum in the company of the third king Charles.

To reiterate, my view of the Interregnum is that it has three phrases at least and here I am heavily influenced by Thomas Kuhn’s Logic of Scientific Revolutions. The first centres around the crises of the old, crumbling order notably in debt and democracy, the second phase around social, legal, and economic superstructures built around new technologies (AI, quantum) as well as the evolving contours of the multipolar world order, and then thirdly, the acceptance and coalescence of new world institutions, governments, and companies around this new world order.

In this context, the question that the under-siege German Chancellor might like an answer to is ‘how long will all of this take?’ or even ‘are we there yet?’ as impatient children might demand of their parents on a long trip.

A first step is to date the starting point of the ‘Interregnum’. Granted that the era of globalization started with the fall of communism (the Berlin Wall) I would bookend it with the July 2020 imposition of the National Security Law by China on Hong Kong, effectively snuffing out Hong Kong’s democracy, and emblematic role as a hub of globalization.

Without going into elaborate detail as to how long the ‘Interregnum’ could take, there are various literatures that might help point the way. One that is popular in the US is the ‘Fourth Turning’ idea as outlined by Neil Howe and William Strauss, that posits that cycles in geopolitics and economics are consistent with 80 year human cycles (broken down into four twenty year phases). So, by their estimation, the next, positive geo-economic phase will start in the late 2030’s.

That date is consistent with other rules of thumb. Samuel Huntington’s waves of democracy theory points to febrile periods of close to twenty years between the peak of one wave of democracy and the start of the next wave. In addition, if one of the two major economies – the US or China was to endure a debt crisis, that is a process (rather than event) that could – to use history as a benchmark, take a good seven years to resolve itself.

The idea that an economic or specifically a debt crisis could shape the ‘next world order’ is consistent with the ideas of Minsky and Kondratieff cycles. Another associated literature would suggest that long run geopolitical ‘paradigms’ are associated with empires (the first wave of globalization was driven by the British Empire). Empires tend on average to last for 250 years, with Rome being the most impressive. America’s empire, built around an unrivalled financial infrastructure, military power and corporate giants, remains intact, but we should worry that Donald Trump may soon play the role of Nero.

The length of paradigms or regimes is something I want to devote more time to, but my instinct is that we are only into the first two years of a near fifteen year ‘Interregnum’.

One interesting aspect of this is the alarming reversal of many upward trends in progress that we had come to take for granted – China’s fast economic growth has stopped, human development and longevity in the US has turned down. New trends and players are emerging – Poland is the most exciting economic and political player in Europe now, the Baltic states are geopolitical micro-powers and Saudi Arabia is shifting from a strict Islamic state to an authoritarian, ‘luxury’ power.

Meanwhile, in Germany, the question is can it endure another fifteen years of Zeitenwende?

Have a great week ahead,

Mike

A few weeks ago we wrote of the ‘Bubble Brewing’ in large US technology stocks. Since then some tech stocks like Tesla have struggled, but the leader in the ‘bubble’ pack Nvidia has powered on though it is becoming more volatile, such that on a given day it rises or falls by the same magnitude of the market capitalisation of well-known European firms like Volkswagen (Nvidia is worth over USD 2 trn, while Volkswagen is worth a paltry USD 65bn).

The disparity in size between what many would consider a giant of European industry (Volkswagen employs 670,000 people half of whom work in Germany) and a fast-growing tech company (Nvidia has roughly 26,000 employees) leads many people to demand that Europe should have its own giant companies. This is not itself a coherent strategy. In the US, the technology giants have become so large as to at very least be oligopolistic, and in some cases monopolistic.

Only the veneer of great power competition where tech giants are part of the competitive arsenal of the great powers makes this level of concentration acceptable (by the way the ten largest companies in the US have the largest share of the stock market since…1929).  

While Europe doesn’t have this problem, a better way to frame the ‘we need to be bigger’ question is to ask what can be done to allow European companies to scale more easily – that after all is the essence of technology led businesses.  With a new European defence procurement strategy being put in place, the EU AI Act in force and a supporting ‘supercomputing’ strategy drive its infrastructure, this question becomes even more pertinent.

When I think of firms that have successfully scaled across Europe, many have done so by mergers and acquisitions (drinks and spirits) and most are in industries with tangible products that appeal across cultures (luxury goods, payment technologies and drinks, again). In most cases, the difficulty in scaling lies in distribution networks – financial services being a good example.

There are many reasons why it is difficult to scale firms across Europe – the lack of deeper capital and venture markets is one. A more telling reason is the cultural and legal complexity of operating across countries with distinct ways of doing things. Within this, the vast majority of European firms – even those fast growing tech firms – tend to have an unavoidable cultural imprint, and these ‘imprints’ make it extremely difficult for firms to go from the ‘national’ to the ‘pan-national’.

For example, whilst many French politicians speak to the idea of pan-national champions, virtually no large French companies have ‘foreigners’ as CEO’s (and few women also). For most executives, the ‘national’ rather than ‘European’ corporate politics matters, in the same way that most European politicians would value a seat in their national parliament more than the European parliament.

What then needs to be done to build large pan-European corporate champions?

First, a few clues come from countries in the geographic and cultural hinterland to the EU. The UK, for instance, used be home to large firms – banks, oil companies and a few tech giants – which is widely regarded as a free-market capitalist economy. The UK should have more mega cap companies but it appears that the shock of Brexit, a longstanding neglect of education and public services and the degradation of the labour market, have undercut its attractiveness. Two other countries that come to mind in a more positive sense are Canada and Switzerland.

Canada doesn’t have any mega-cap companies (it has a bunch of large banks, railway companies and miners) but the breadth of its investment ecosystem strikes me as one for Europe to emulate. It is one of the few economies (it has the same population as Poland and 10 million less than Spain) to have a range of successful venture, private equity, infrastructure, and agriculture investment firms and very large pension funds, thanks mostly to progressive pension and tax laws.

Switzerland is perhaps a beacon for Europe. Despite the fact that it has a population that is only 12% of that of Germany, its stock market is just half the size of that of Germany (Switzerland has a more impressive stock market to GDP and population ratios than the US), and Switzerland has a range of large global firms such as Nestle and UBS. There are a few elements for Europeans to focus on, notwithstanding the fact that Switzerland is very much the exception.

One is that Switzerland has a well-developed capital markets and a large pool of savings capital (a lot of it comes from outside Switzerland), a developed financial markets eco-system, a lively market for executive labour, high levels of research and development and heavy investment in education (front skills based apprentice schools to top flight universities like ETH). Digesting the Swiss recipe for success, and that of other countries might lead to the following suggestions.

The Swiss example might point to the need for greater private funding (through endowments) of universities, spread across departments so that developments in physics are matched by the legal and philosophical frameworks that should accompany the deployment of new technologies. It might also point to better funding of pensions and the ability for pension funds to invest in a wider range of asset classes. There is also a need for the European Investment Bank to make greater equity investments, and potentially greater coordination between corporate venture capital firms across Europe.

More generally, Europe needs to think about corporate governance on a pan-European level, to reiterate a recommendation we made in ‘The Levelling’

‘One such proposal would be to harmonize the processes involved in setting up a business. The European Union could establish an EU-level process whereby entrepreneurs could adopt an EU template for setting up a business such that it would take the same amount of time to establish a business anywhere in the European Union. The EU entrepreneur template should ideally make the early stages of the life of a business as uncomplicated as possible and it could be a basis to harmonize laws across specific topics, such as bankruptcy, prosecution of corruption, and labour laws. This would be a much more meaningful reform than deeper political uniformity’. 

This proposal could for example be established under the EU Horizon programme, and with deeper pools of capital might be the beginnings of a cadre of European corporate champions.

As a final comment, perhaps the greatest obstacle to policy action on building corporate ‘champions’, is that there are no votes in this as a political issue in Europe, and therefore little impetus for change.

Have a great week ahead,

Mike

An early, formative career experience of mine was an internship in the City of London, where I sat a few metres away from the office of Gavyn Davies, then (and now) a very prominent economist. He was instrumental behind the scenes, in spurring some of the early policies of the New Labour government of the 1990’s, such as the radical move to give the Bank of England its independence.

At the time, one of the great tasks of City economists was the parsing of the Budget. Budgets were great set pieces affairs, dramatized by Chancellors like Ken Clarke sipping whiskey as he delivered the Budget. Trolleys of sandwiches (and a few whiskies) would be delivered to economist’s desks as they made sense of the Budget and then transmitted their views to gilt, currency and equity investors. The Budget was a frontpage story for nearly all newspapers.

Today, the Budget is a whimpery affair. The speed of telecoms, pre-releases and the spinning and whispering of press secretaries mean that the interesting detail reaches markets and the press well before the Chancellor stands up. In addition, bond markets today are more sensitive to inflation figures and the manipulation of central banks, so they are less sensitive to fiscal tweaking.

As Jeremy Hunt delivered his Budget, there were effectively two ‘elephants’ in the room.

The first is that this year is an election year (possibly May but more likely November), and the second is that the sense checking by the Office for Budget Responsibility that accompanied the delivery of the Budget, made it very clear that the scope for fiscal manoeuvre (the Chancellor is constrained by a fiscal framework) is very limited. In particular (depending on how we measure it), government debt to GDP is close to 100%, a historically high level and one that should set alarm bells ringing.

The very limited set of options open to Jeremy Hunt was a perfect illustration of how, when government debt hits record levels, policy choices are severely curbed.

A report by the respected Institute for Fiscal Studies the day after the Budget made this very clear, even a recent BBC 4 radio interview with Hunt’s junior minister Laura Trott laid bare the fact that few senior politicians have a grasp on the UK’s indebtedness problem.

What is happening in the UK, Europe and in the US, is that debt is smothering politics in the sense that the financial burden that high levels of debt produce (in the context of high interest rates), reduces the policy options that governments have.

To an extent, reflecting the euro-zone crisis, governments are now the wards of bond markets (and their own fiscal rules). To stick with the example of the UK, though it is much the same for neighbouring countries like France, Jeremy Hunt brandished GBP 10bn worth of tax cuts, but he will spend eleven times that on debt interest payments.

I do not think enough attention is given to the ‘debt smothering politics’ thesis, but we can start to think of its implications.

Against a backdrop of elections throughout 2024 and a broader ‘democratic recession’, the idea of debt dominating fiscal policy may cause further disenchantment with politics. It might also drive politicians to focus much more on identity politics and polemic issues like immigration (as is the case in France and Italy) and to become speculative and populist on economic policy (expect talk of ‘taking chainsaws to debt loads’).

A less pessimistic view is that much reduced fiscal space means that there are fewer means to ‘buy off’ voters (Jeremy Hunt’s budget was a case in point) and that as result political leaders are induced to reform public services and possibly, public life, along the lines of the playbook introduced by the ‘Troika’ to Greece and Ireland in the aftermath of the euro-zone crisis.

In turn the debate may turn to economic growth and what the UK for example, might learn from neighbouring countries like Ireland, or even how economic and financial reform in the aftermath of the Napoleonic Wars (debt was extremely high) permitted the English economy to outperform the French one.

Before we arrive at that rosy scenario, I suspect that the first port of call for debt-burdened politicians will be central banks. Notably the Bank of Japan has swallowed over half of the national debt market, which has reduced the short-term consequences of indebtedness, but increases the risk of an ultimate, existential crisis.

In an indebted world there will be greater pressure on central banks to compromise themselves and act in ways (i.e. control the level of bond yields) that reduce the political consequences of indebtedness. In this respect the US could prove interesting if Donald Trump becomes president.

He doesn’t like taxes, and is unlikely to want to raise them, but cutting them may lead to a rise in bond yields. As result, one of his first moves may be to replace Jerome Powell with a more overtly political Fed chair (markets may not like this either). If that doesn’t work, he might start to threaten to chainsaw the national debt. America might then have the crisis Trump deserves.

Have a great week ahead

Mike