Baldwin’s Beard

Baldwin’s Beard

One of the notable, recent developments in the arcane world of economics was the news that Andy Haldane, the chief economist of the Bank of England is to leave the Bank in September (to become the chief executive of the Royal Society for Arts).

Haldane is an interesting character, aware of the need to broaden the public appeal and communication of economics, and who has a gift for the obscure but telling anecdote. For instance, in one paper on lending he highlighted how the beard of the 12th century King Baldwin II of Jerusalem (originally from the north east of France), was used as collateral for a loan. Then, in an address to the influential Jackson Hole central banker gathering, Haldane delivered a paper called ‘The Dog and the Frisbee’. It says much about the dullness of central banking that the paper was greeted with raised eyebrows.

Haldane’s latest paper is on inflation (link below), where like any well trained economist he gave on one hand the reasons inflation could continue to be well contained and on the other, why there are compelling forces that drive it higher. Haldane concluded by coming out in favour of the higher inflation thesis, which may make him unpopular at the Bank – it is the fashion amongst central bankers to deny the risk that inflation could shift higher (at a time when market expectations of inflation are at multi-year highs).

I have flagged the risks of inflation to markets recently (‘Return of the Prodigal Economy’, March 27), and while volatility in the bond market has calmed, equities are encroaching on valuation extremes and market metrics like margin debt are very high. This is not yet accompanied by extremes in sentiment (e.g. complacency) but it does beg the question for most investors (institutions, pension funds, family offices and the like) as to whether equities can continue to produce positive returns. In the context of historical returns, there would have to be a very strong upturn in earnings, and a flattening out of interest rates, for equities to offer more upside.

The argument that equities have reached or are close to a slowing in upward momentum is a more nuanced one than ‘when is the next crash?’ A clue to the way ahead comes from the imprint of markets over the last year – lumber, gasoline, pork, oil, ethanol, soybeans, and small cap stocks are the best performers while government bonds, volatility and the dollar are the worst performers, a pattern that points to higher growth and higher inflation. To that end, markets will continue to be driven by the narrative surrounding the speed and ‘temperature’ of the recovery.

A more pernicious side-effect of inflation if we do see it (depends much on the velocity of money in the economy) is the impact of food prices on emerging economies. One way to think about this is to consider the UN FAO world food price index which since 2015 has hovered around the 100 level, but in the past six months has jumped to 120.

This move, should it persist, represents a high, large cost to families in the emerging world (who spend a large share of their disposable income on food staples). Add to this the high toll of coronavirus in countries like India, Russia and brazil, not to mention currency and bond volatility, and the prospect is that the coming decade could be as problematic for emerging markets as the 2000’s were glorious.

Whether this is the case or not, goes back to Baldwin’s beard. When Baldwin of Bourgogne (and Jerusalem) lived, real interest (loans) rates where in the mid-twenties, and economies oscillated from high inflation to deep deflation (the Crusades had a marked impact on land prices across Europe). There were some notable, subsequent highs in rates – mid 16th century Flanders, the reign of Charles II in England and a spike around the time of the Napoleonic wars. Despite that, the historic trend in rates has been downwards, markedly so as Western economies managed to get inflation under control in the 1990’s and as globalisation led to deeper commoditisation of prices.

The very, very big picture question then (going back to the 12th century), is whether we are at a historic low in rates, and that in certain countries they will move higher as growth and inflation finally pick up, as in some cases country risk premia rise and as the weight of a multi-century high in debt to GDP ratio is felt.  

If rates rise, it will result in one of the biggest changes in fortune across countries in decades, perhaps centuries. The emerging economic world could be at the epicentre of this because it is at the tail end of the inflation tiger. To that end, emerging economies need to think of how to recover from the deadly effects of COVID, whilst keeping their financial systems strong and stable.

Have a great week ahead


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