Remaking a World on Fire

It has been an eventful year for me, but the most striking moment was witnessing the fire at Notre Dame cathedral. Having run towards it, I was unprepared for the extent of the conflagration, green and orange flames bellowing out of the church as the sun blazed angrily in the background. It was a traumatic evening, where thousands of onlookers were silenced by the significance of what they saw.

At the same time, it would be wrong of me to try to draw a parallel between such an apocalyptic event and the state of our fracturing world, though that thought is at the back of my head, not least given the way in which the ‘old’ world order is increasingly vandalized by politicians, not to mention the outbreak of protests around the world.

A better parallel, as supersized cranes moved around Notre Dame this week, is that the time it will take to rebuild and remake the church, some five or more years, will also be the period of time required to put the era of globalization behind us and have the makings of the ‘next world order’.

The roadmap towards this ‘order’ will look something like this – economically the world will grapple with the ‘next recession’ which will be more severe in indebted economic sectors (China’s economy, corporate USA and some emerging countries), and will eventually culminate in some form of world debt conference. Once this is accomplished, the quest for a model of organic economic growth will begin.

Politically, I hope that we will see more independent, bottom up efforts by individuals and new groups/parties to rethink what the contract between people and those who govern for them will look like. Then in terms of geopolitics, the world will be increasingly dominated by the ways in which the three great ‘powers’ – the EU, USA and China pursue different paths on issues like the internet, democracy, human development and finance. This is a limited, big picture sketch, the rest is of course in the Levelling.

Forecasting – really more a form of ‘macrotainment’ than a science – is easier on a five year view, but given it is the end of the year, I also want to offer up a few pointers on at least two events over the next few months.

First, I expect economic and political headlines to be first driven by the unravelling of China’s credit boom – we will hear more about defaults of indebted Chinese companies and resulting pressure on its banks. Expect ‘China is Spain’ to be a headline we see a lot. The policy task for China’s leaders will be complicated by ongoing protests in Hong Kong and importantly, the result of Presidential elections in Taiwan on January 11^th. My guess is that one result will be a drop in Chinese interest rates in 2020.

Second, impeachment will deepen America’s divides. With the process now started, it looks for right or wrong, that the Senate will not vote to impeach President Trump. The trial itself, especially if likes of Mick Mulvaney and John Bolton are called as witnesses, will prove a spectacle.

If we bear in mind that Bill Clinton responded to his impeachment with airstrikes on Iraq, then Trump’s emotional letter to Senators is mild by comparison. He may try other means of weaponizing impeachment – link it to the stock market (Trump has sent 21 tweets about the stock market in the last 30 days, the most since 2018), trade policy with Europe or immigration.

The immediate political implication of the Senate not impeaching the President is that the Democrats lose their ‘silver bullet’ against Trump, and with it the sense that morality, the law and institutions are powerful buttresses against bad behavior. In turn, this will colour the Democratic Presidential selection process. The Democratic candidate will need to have a very clear policy message, an ability to scrap with Trump in the political gutter (see my October 13 blog ‘Don the Robber’, https://thelevelling.blog/2019/10/13/donthe-robber/). So far, none of the leading Democratic candidates is strong on these points (someone like Mike Duggan of Detroit could fit this bill in my view).

For Trump, and his supporters, a failed impeachment will open up the road to the acceleration of his policies on immigration, trade (EU) and on identity-based politics. Mounting, structural risks like climate damage and indebtedness will get worse. The next election will be driven by identity, race and values, and there is a very good chance that Trump could win.

So, enjoy this Christmas, there is plenty of disruption to come in 2020!

I am back in touch on January 12.

With best wishes, Mike

Paul Volcker

This important week has been marked by the passing of Paul Volcker. Many commentators have already paid tribute to a remarkable man. Martin Wolf in the Financial Times referred to him as the ‘greatest man I have known’.

I have never met Volcker (though am privileged to share an excellent editor with him in John Mahaney at PublicAffairs who has edited ‘Keeping at it’) but I wanted to write about him because his legacy touches on the themes in ‘The Levelling’, and more importantly on the state of the world today.

In that context, Volcker stands for many of the things that are missing in our international political economy – a willingness to take unpopular though telling policy actions, the independence of central banks from markets and politicians, and the integrity of those in public life.

His accomplishments as a central banker, his role in helping survivors of the Holocaust recover their savings from the Swiss banks and his views on banking (i.e. the Volcker Rule) underline these qualities.

When he was appointed as Chair of the Federal Reserve, the central bank was nothing as powerful as it is today. Arthur Burns, the Chair from 1970 to 1978, was widely seen as being close to President Nixon, and had later been undermined by the Nixon White House. William Miller who followed Burns, had a short and inglorious career as a central banker (March 1978 to August 1979) and was promoted ‘out of the way’ to become Treasury Secretary. His legacy, a sharply weaker dollar and inflation barreling towards 15%, is beyond the imagination of many people today. Bluntly, high inflation became the policy problem of the day.

Volcker took the reins at the Fed with a clear view as to what needed to be done (‘This is going to be tough, but we are going to stick with it and the inflation rate is going to come down’). To the credit of President Carter who appointed Volcker, Carter also understood the consequences of what Volcker would do. During Volcker’s ‘job interview’ with Carter, Volcker thrice stressed the magnitude of the policy task at hand, to which Carter acquiesced.

By the mid 1980’s Volcker’s medicine was taking effect. Inflation was falling, but the personal costs of his role were also growing. Homebuilders regularly sent him blocks of wood to remind him of the burden that high rates were having on the housing market, and threats to his safety meant that Volcker needed a bodyguard.

Political resistance was also growing. In his book, Volcker mentions a meeting with President Reagan and his chief of staff, James Baker, where Baker reportedly insisted that Volcker not raise interest rates at a forthcoming Fed rate setting committee. Volcker’s response was to get up and leave the meeting.

Thus he cemented the independence of the Fed (Reagan later appointed several White House ‘friendly’ board members to the Fed to stymie Volcker), drove down inflation and in doing so triggered perhaps the most important macro trend of the past thirty years in the shape of the permanent, lower resetting of interest rates and inflation.

This enabled the economic boom in Reagan’s America and provided the structural basis for globalization. Globalization could not have happened and survived if the US economy, and by extension the rest of the world, had had to endure bouts of high inflation and sharp rises in interest rates. Many people today will know little about Volcker, but in a fundamental way, his actions have impacted their lives.

In the sense of the way in which we read our world today, Volcker could be described as an ‘anti-populist’. He was a humble technocrat, or expert, who confronted very tough decisions, with unpopular side-effects. There are at least two reasons as to why he should be studied.

The first is that the world is beset by the accumulation of near existential risks – indebtedness is the highest it has been since the second world war and the Napoleonic Wars before that and, the climate is warming at a rate never seen in the past two hundred years and many cities suffer paralyzing pollution. These and other risks badly need a Volcker type character to resolve them, or else they will be patched up in a crisis. Policy makers need courage, rather than new frameworks.

This is doubly true in a world where the ECB and the Fed are experimenting with new ways of encroaching into the political economy and by extension, of distorting markets. Quantitative easing and negative interest rates have not created organic economic growth. Instead they drive asset bubbles, build wealth inequality and give reckless politicians the cover to engage in poor policy (i.e. Trump’s trade war). Developed world monetary policy risks fatally compromising itself. Volcker would not approve, neither should we.

Deal done – Trump saves euro!

In a missive I wrote earlier this year I puzzled whether Trump would fall victim to the same policy mistakes as Herbert Hoover (‘Is Trump Hoover?’,https://thelevelling.blog/2019/08/11/is-trump-hoover/). This does increasingly look to be the case, as the economy is slowed down by the debilitating consequences of trump’s trade war with China.

However, a reading of the Art of the Deal (consider quotes like ‘I’m the first to admit that I am very competitive and that I’ll do nearly anything within legal bounds to win. Sometimes, part of making a deal is denigrating your competition’) hint at some method behind this week’s trade related threats to China, the EU and France, not to mention the ongoing undermining of NATO.

It grants far too much credit to Donald Trump to describe him as the architect of a new world order, rather he is the bull in a china shop of increasingly brittle crockery. His role, in the context of the fracturing of the old, globalized word order is to help highlight what elements in that world order are fragile and which ones are resilient. The checks and balances in the US political system, and the wisdom embedded in them through the Federalist Papers for instance, are so far proving resilient.

Arriving in Europe this week, Trump clearly had two targets in mind – the EU and NATO, both of which lie on the deepening faultline of the consequences of America’s diplomatic estrangement from Europe. Trump has rarely had anything better to offer either institution save scorn and division. In my view this is a pity, and simply wrong.

NATO and the EU are fine examples of how collective action usually requires a strong common cause to enforce it, and that absent the magnetism of that common cause (broadly speaking the Cold War), cohesion between members begins to ebb. In addition, both institutions are finding that they have a common design flaw – namely the lack of an exit. Neither NATO nor the EU (not to mention the euro-zone) have processes where a recalcitrant member can be kicked out. Brexit shows us that even those who volunteer to leave, find it difficult.

To make an analogy, no public building can be used without a fire escape or carefully marked ‘exit’ in place, and it should be the same for multi-lateral institutions in a changing, multipolar world. This multipolar world is one where nations will increasingly have to take sides. In this context, Turkey’s membership of NATO will become increasingly problematic, and the position of EU members like Hungary, and prospective candidates like Serbia also looks strained. My prediction is that both NATO and the EU will have to change their uni-directional membership rules to include a ‘black-balling’ process.

That NATO rests on the emerging faultline of US-EU relations gives us a clue as to its future. The logical contradiction is that the White House could soon declare a trade war on Europe, at the same time as partnering with the EU to fight ‘real’ wars. To paraphrase Justin Trudeau, it is enough to make ‘jaws drop’, though it is not as peculiar as it seems. For instance, in October, as the final wrangling over the UK’s Brexit deal was taking place, French commandos joined their British counterparts in a joint operation called ‘Griffin Strike’, part of a larger cooperative exercise between Europe’s two military powers.

One way for the EU to contribute to its own security in the context of a multipolar world where the US is a less unambiguous ally, apart from making sure its military kit works (only one sixth of German helicopters and fighter planes are operational), is to develop its power as an economic and financial player.

Theoretically this approach fits into the ‘total war’ doctrine developed by Russian General Valery Gerasimov, where financial networks are just as useful strategic tools as fleets of submarines. The effect of American sanctions on Iran is one recent, powerful example of this.

To that end, the new Commission has a long task list, but it should focus on the following. First, bolster the international credibility of the euro by enforcing the Maastricht guidelines of debt levels to the point that countries with debt above the Maastricht threshold should have a portion of their debt deemed ineligible for ECB purchases and for collateral exchange.

Second, continue to clean up the follow of ‘dirty’ money across Europe’s banks and fintech players. The relatively new EBA (European Banking Authority) has failed to do this. Third, think how infrastructure development in countries like Poland and Greece can be better supported by the EU and by EU based private investors, instead of those countries swaying towards Chinese state led investment.

If these and are other measures are enacted, Donald Trump may prove the catalyst for a stronger euro financial system.

Have a great week ahead,

Mike