Time for a Panic?

This week, some one hundred and sixty three years ago, the ‘Panic of 1857’ began. As is typically the case, the panic was preceded by years of overinvestment by banks and investment trusts, much of it in land and railway infrastructure. The fuel for this speculation was provided by a rise in the supply of gold.

Several factors – a sudden drop in the availability of gold (the sinking of the SS Central America with gold bullion on board didn’t help), falling grain prices and a prominent bank failure in Ohio set in motion a protracted market and economic slump. Political turmoil was also an ingredient, especially so in respect of slavery, which was to then lead to the US Civil War.

There are several parallels to recall the ’57 panic today, not least being the coronavirus market panic of March. The US is troubled politically, new technologies are on the rise (i.e. the telegraph in the 1850’s), there are geopolitical stresses afoot (the Crimea War had just ended) and plentiful money supply coupled with exuberant investment deals are a sign of our times. Notably in markets, the investor mood is described by euphoria rather than panic.

Amidst today’s financial market euphoria, many find the apparent contradiction between successive records in the stock market (mostly the Nasdaq) and multi-decade highs in unemployment, growing credit stress, a global public health emergency and generalized political chaos, to be troubling and also, a moral quandary. I share this view but, would also stress that the real world and the market world can remain at odds for extended periods of time.

One clue to this is central banks. The numerous ‘panics’ of the 19^th century were brutal though often short, because central banks in the sense we know them today, did not exist then. Market crises tended to resolve themselves in violent ways. The Bank of England did play an important role though it was perhaps not until after the ‘Panic of 1866’ that the crisis fighting playbook was written up in Walter Bagehot’s ‘Lombard Street’.

In contrast, today’s central banks are monetary deathstars, towering over markets and economies and blasting them with liquidity shots. This much was clear in the speech given by Federal Reserve Chair Jerome Powell to the (virtual) Kansas Fed Banking symposium where he outlined the Fed’s intention to effectively overshoot its inflation target.

In so doing, the Fed risks further splitting American society between ‘speculators’ (those who have access to capital and benefit from asset price inflation) and those who have to live in ‘panic’ type conditions (credit stress, unemployment, rising costs of living).

One indicator that helps elucidate this difference is lumber prices – which have risen by 250% since March. Logically this might be because more people are redoing or building homes, but the ascent of lumber looks very like that of the Apple share price and suggests that in this world characterized by ‘the financialization of everything’, speculation is the driver of lumber prices.

There are other indicators – the presence of a growing number of market anomalies such as the 30% rise in the price of Tesla and Apple as a result of stock splits (ordinarily this move would not have much of a price effect).

Since the global financial crisis, the side-effects of very generous monetary policy have been a rapid accumulation of indebtedness by governments and companies, and the detrimental impact of negative interest rates on the profitability of banks (note that while Apple has doubled in value since March, Wells Fargo’s equity trades close to its lows). Both factors – high indebtedness and constrained banks – weaken the link between monetary policy and the real economy.

The additional risk with the Fed’s stance is to create inequalities across generations. Allowing inflation to overshoot, in the absence of strong wage growth will make it more expensive to fund a pension, to buy a house and also to afford private education and healthcare.

In a world where America has a President who is uniquely (tweets) attached to the fortunes of the stock market, the vapours of speculation create the illusion that all is well, that debt and deficits can continue to rise and that growing poverty and long-term unemployment can be cured by Robinhood.

Finally, some of you may be asking the question as to whether we have another market ‘panic’. I don’t like trying to predict big market moves – those who do usually need to be lucky and/or patient. However, bear in mind that stimulus programs are petering out, bankruptcies and restructurings are on the rise, geopolitical skirmishing nearly pandemic (Russia-USA in north east Syria, China-US in the South China Sea, Turkey v the rest in the Mediterranean, together with tense wargames in the Baltic).

We may not have a ‘panic’ in September, but volatility will rise.

Have a great week ahead,

Mike

Did I miss anything?

In early March, Daniel Thorson who works in a ‘mindful learning’ centre in Vermont went on a seventy five day silent retreat. When the retreat ended in late May, one of his first acts on reconnecting with society was to tweet ‘Did I miss anything? What about the Australian wildfires?’

He may well wish he had not broken the tranquility of his retreat, given the flood of extreme events we have witnessed this year from the assassination of an Iranian commander, to the suppression of democracy in Hong Kong to the odd combination of double-digit unemployment and record highs for stocks.

The latest such event this year, the tragic explosion in Beirut last week, has amongst many other things contributed to a sense that 2020 is an inordinately event rich year.

The logical, in my view, explanation for this is that many of the tectonic or volcanic shifts that have been slowly building in recent years, are now surfacing, and in particular have been catalyzed by the coronavirus crisis.

Climate damage is one such risk whose side-effects are now more and more manifest. To also take Lebanon as an example, long running geopolitical tensions, profound corruption and a dysfunctional bureaucracy have already spurred a debt crisis in Lebanon, and now they have combined to produce a more deadly crisis.

In this sense, 2020 is a turning point, and a great stress test of the world order. With the holidays (at home!) now upon us, its not a bad idea to look back and trace the trends whose rise has been exacerbated by the coronavirus crisis, and those are just now starting to become apparent.

In brief – because I have covered these topics in detail in recent posts, 2020 has seen globalization well and truly crashed by the coronavirus crisis, and replaced by an emerging multipolar world the signature elements of which are the lack of collaboration between the large regions (EU, China and US) and their increasingly different responses to economic policy, democracy, and the internet to mention a few areas. Economically, the dominance of central banks has been augmented, indebtedness has risen towards levels (relative to GDP) not seen since the end of the Napoleonic Wars.

This means that at very least, the idea of the economic cycle is dead. Markets, investment and economies will orbit around the contest between central bank death stars and the gravitational pull of credit risk. There are two implications for markets. One is that extremes in inflation or deflation will be found in asset prices rather than in real economies. Relatedly, it will be some time before we understand how 2020 has scarred consumer preferences (and savings habits).

Second, it means that investors will increasingly seek out ‘new assets’ (new assets are really old assets whose ownership and risk characteristics have been adjusted) that are created through new types of debt issue (such as EU bonds), distress and bankruptcy, asset sales from restructurings and then more inventive securities in sectors like healthcare and biotechnology.

One of the other important discoveries of 2020 is the disparity in policy and adaptability between countries. This was evident across Europe, and tellingly across states in the USA. Europe has however emerged stronger from the crisis, or the knee jerk reaction that the European project would fall apart has been proven wrong. In contrast the US has emerged weakened and arguably more divided.

To a certain extent this has been reflected in recent dollar weakness. A glance at Turkey gives a good illustration of how the degradation of a country’s institutions can translate into diminished financial credibility (the lira has fallen sharply this year). The rule of law has rarely been a factor in markets, but in developed countries like the US, sustained attacks on institutions and the rule of law can have economic consequences. Here, while falling interest rates have also helped to push the dollar lower, a sustained crisis of confidence in the US (and its currency) is one of the risks to watch into the second part of the year.

The post holiday period is very likely to be filled with noisy predictions on the shape of the economic recovery, and the outcome of the US election. My instinct is to continue to track the outcomes associated with a multipolar world (i.e. Europe regulates tech, builds a green economy but fails to drive banking consolidation and a capital markets union), the financialization of everything (healthcare is next after technology) and the accelerated rise and fall of nations.

I’m taking a ‘silent retreat’ of my own from this missive and it will return on August 30th.

With very best wishes

Mike

TechTok

Technology now a national strategic issue

There is no better template for the state of the world than the technology industry. In the highly globalized world of the mid 2000’s, Google had one third of the internet search market in China, while today it has close to zero. The internet is becoming multipolar – the US has internet giants that have become stock market monsters, Europe has few tech giants of its own but is leading the regulatory charge on technology, whilst China has on one hand ring fenced its internet space, whilst at the same time generating the world’s leading thriving e-commerce sector and driving tech into social policy.

Technology is interesting in many other respects, but the one I find thrilling is the way it now crosses into every domain – politics, economics, markets and society. It arguably is more pervasive than the new technologies of prior periods of globalization – such as the steam engine and railways (though the technology sector will never match the 60% share of the market capitalization of the US market that railways enjoyed in 1900).

It is not surprising then that there is a broad feeling that tech is too big for its boots. Economically, e-commerce firms like Amazon are big enough to have pricing, scale and distributional advantages that suppress smaller players (and that large ones like Walmart do not seem able to match) and the same may be true of Apple’s Appstore supermarket. Google and Facebook have become advertising behemoths and politically indispensable. Financially, these firms now account for nearly a quarter of the market capitalization of the US market (Apple added USD 170 bn in market capitalization on Friday alone), and as such have become a huge ‘swing’ factor for pension funds, the ETF (exchange traded fund) industry and day traders.

The technology industry, in the USA, India and China, has become the locus of wealth inequality – creating vast fortunes for tech owners. Moreover, tech giants vastly distort both entrepreneurship and innovation. During the testimony of the CEO’s of the large US tech firms to Congress it was revealed that Facebook had adopted a strategy of stifling competitive threats by buying them. The same might be true of other tech behemoths.

If so, the danger here is to stunt the growth of new tech eco systems, to distort innovation in that new companies are built for ‘takeover’ rather than to solve new industry problems, and to hoard the fruits of innovation within a few corporations.

The ‘what to do about tech’ should be clear to anti-trust lawyers and economists concerned with monopoly power. To this end, breaking up the large technology companies in the same fashion as the dismantling of Standard Oil in 1911 or even the Glass-Steagall act of 1933 is an option. Another approach would be to embargo tech giants buying smaller companies so as to give new tech ecosystems a chance to thrive (note how the US failed to develop a 5G ecosystem).

A more likely option is to leave the tech monoliths in place but tax them (and possibly their owners) and harvest the fruits of their superstructures. Ideally this revenue would be funneled to education, digital literacy and cybersecurity. Even the EU sees this opportunity, and plans to fund part of its recent Recovery and Resilience plan with a digital tax – though implementing this will be difficult.

What to do about tech is less clear if you are a politician – technology has replaced television and radio as the way of reaching hearts and minds, the tech community is a source of donations, and in a multipolar world it is a strategic, security related asset. In that context one option is to deepen the ties between the state and the technology complex, as China is doing.

If anything, the signs are that the US will follow the Chinese model, notably so with suggestions that Microsoft might buy TikTok, the increasing use of camera and home security system (from Amazon) data and the growing ties between the likes of Microsoft and the government in cybersecurity.

If the relationship between American tech monopolies and the state is to become even more symbiotic, it will still have rules. One for example is that in areas where the state has a monopoly, tech will not be allowed to encroach. The best illustration here is the role of the dollar and the failure of Facebook’s Libra payment system to take off. Another consideration is what vision the large technology companies have for the US – many of them may well prefer a more data intensive world, where technology is even more deeply embedded in governance…which again takes the US towards China’s model.

Where will this leave Europe? By default of not having managed to create its own tech giants (and I am skeptical that it will be able to do so soon) the EU can focus on raising the standards on data protection, digital identity and payment systems. It needs to also make real progress on capital markets union and on incentivizing tech entrepreneurs at a pan EU level so that companies like Stripe can thrive in Europe. If it doesn’t it may become a tech colony, and a paradise for non-tech industries, from tourism to wine to good food!.

Have a great week ahead,

Mike