Crisis, What Crisis?

After an absence of over eighteen months, I made it across the Channel to the UK. Such has been the barrage of Brexit bad spirit from political marauders like David Frost and tales of fuel, labour and food shortages, not to mention rising COVID cases, have been so apocalyptic that I worried I might not make it through the Channel tunnel. Thus, expecting to perform a Bond like infiltration behind enemy lines, I, passenger locator form between my teeth, turned up early at the Gare du Nord Eurostar terminal.

The great surprise was that the trip through both passport controls took a total of three minutes, tribute less to my Bond style skills of evasion but more to the robots manning UK passport control. This speedy passage set me wondering whether the UK’s budding Winter of Discontent is just a political mirage or, as some hold, a building economic catastrophe.

My own experience, limited to central London, was that prices were considerably higher than I could remember, staff shortages were evident across the board (coffee shops closed early, a restaurant booking was cancelled because of lack of staff, and the passport control at St Pancras exit poorly manned). Plenty of anecdotes were passed to me regarding petrol shortages and general blockages in freight and goods.

In the markets, short term bond rates (two year gilts) have rocketed from 0% to 0.60%, investors are pricing in very high inflation in swap markets together with a rate increase this year from the Bank of England. Taken together, it does not auger well for post-Brexit Britain, and I suspect that as winter approaches, more and more commentators will trot out the ‘Winter of Discontent’ headline.

There are appealing parallels between the situation today and that of the late 1970’s ‘Discontent’.

For example, a lorry driver strike during the winter of ‘78/’79 is matched by the current Brexit induced lorry driver shortage, and in the 1970’s food shortages and high inflation led to misery (though far more pronounced than today).

Famously in early 1979 the then prime minister Jim Callahan returned from an international political summit in the Caribbean, joked about having swum in the warm sea there and then blamed the media for exaggerating the chaos gripping Britain. The next day he was greeted by a headline in the Sun that went ‘Crisis, What Crisis?’ and thus his political demise accelerated. Fittingly, Boris Johnson has spent much of the week in Marbella, though so far, he has the media on his side.

He and colleagues will blame inflation and shortages on international supply chain issues, though he has so far done a very poor job of mastering and marshalling the economic side effects of Brexit. The fact that Northern Ireland has had far fewer supply chain and labour market issues, and has seen trade with the Republic pick up noticeably, suggests that Brexit rather than global supply chain problems are provoking discontent in England.

The lesson I take (a few weeks ago I wrote on the political volatility that higher inflation would create, A Face in the Crowd) from the late 1970’s winter of discontent is that it produced a political revolution – Callahan, the unions and the Labour party were discredited, and this prepared the ground for Margaret Thatcher to come to power. In that light the question is whether, following the shock of Brexit, another political revolution is brewing.

Two avenues present themselves – there is much chatter about Boris Johnson’s reluctance to remain in Downing Street for long, and the Labour party has shown itself incapable of scoring into the open goals that the post Brexit environment has provided. This opens up the way for new leaders to come through on the left and centre – though I am hard pressed to identify many candidates.

Having written much about the rigidity of the two-party system in the UK, and the failure of political entrepreneurship (a few recent initiatives to launch new political parties have fizzled out). If there are to be revolutions I suspect that the middle ground of the Tory party is one place to watch, the possibility that moderate parties in Northern Ireland like the Alliance and some independent candidates gain in popularity, and of course that Scottish independence reshapes the political dynamic and power of Britain.

While it would be tempting to conclude that Britain is a Brexit basket case, my long running theory is that politically Britain is a crucible for many of the forces that have driven globalization and that are now undercutting it. In that framework, Brexit was simply the first major rupture in the beginning of the end of globalization, and by extension, the rule is that what happens in Britain will later reverberate across other countries.

The risk then is that we have a global ‘winter of discontent’. There are some signs of this – coal prices have quadrupled in China, cargo ships are blocked up around the coast of the US where amongst other effects meat prices are rising, and Congress woman Alexandria Ocasio Cortez has been tweeting in favour of ‘Striketober’. The only comforting observation I have found is that the front page of the Economist talks of an energy crisis, which according to my ‘Economist frontpage’ rule of thumb, signals the end of the crisis.

The broad risk, to draw all of these strands together, is that the rise in prices of food, labour and energy proves to be more enduring than transitory. Central bankers have largely read prices rises as ‘transitory’, but a research paper from an important figure in the arcane world of central banking (Jeremy Rudd) suggests that central banks are complacent about inflation. If interest rates have to rise more quickly that households are ready for, a rise in the price of a pint of beer will be the least of our worries.  

Well Sealed Windows

When Willy Brandt came to power (as German Chancellor) in October 1969 his first speech to the Bundestag (then in Bonn) contained phrases like ‘we want to dare more democracy’, ‘we want a society which offers more freedom and requires more shared responsibility’, and ‘we want to be and to become a nation of good neighbours’.

Brandt was one of maybe five prominent, respected and enduring Chancellors (starting with Adenhauer, Schmidt, Kohl and of course Merkel – with apologies to Gerhard Schröder who doesn’t make my list) who brought stability to Germany and who managed to fulfill Brandt’s desire of being a good democracy (to the extent that when asked a few years ago what she associated with Germany, Angela Merkel replied: well-sealed windows). 

As I write, Olaf Scholz has a chance to join this list because the arithmetic of the recent election dictates that he will most likely head a new coalition government, which some describe as a traffic light government (SDP in red, Greens and FDP in yellow). One might also think of it in terms of an ESG government in the sense of the responsible investing terminology (Environment, Social and Governance). Unlike many other European countries, there seems to be a willingness amongst these three parties to put together a workable government.

Yet, if Scholz does indeed lead the government, he may immediately suffer from two political curses.

The first is what I call the ‘curse of political giants’, which also holds across football and industry and highlights that whenever a dominant leader retires (think Merkel or Sir Alex Ferguson) there is a messy interregnum, usually involving several short lived leaders, until a new leader proper with his or her own ideas comes along. Football fans will get the analogy if I say that the risk for Scholz is that he is the David Moyes of German politics rather than the Juergen Klopp! (Armin Laschet is the Mourinho of German politics?)

The second risk is what I call the ‘curse of NO’. Someone on the European political stage (I think it was Enda Kenny) wittily described European political summits along the lines of ‘everyone agrees….and then Angela Merkel says ‘no’.

Merkel’s long won stature as a leader and the economic power of her country gave her immense power. Scholz will, like most political mortals, lack this magic power, and will also have to contend with some strong personalities in his cabinet (I have already written on Annalena Baerbock).

Some commentators may argue that this adds up to a recipe for introspection and inaction on the part of the next German government, and that the atrophying of Germany’s already modest army is just another sign of its weakness (a popular view in the AUKUS countries). In fact, it may well be that Germany represents the future – a progressive country where the Greens are an increasingly normal (than fringe) party.

Indeed, taking the triumvirate of the three large European countries – France, Germany and Italy one could and should hold that they stand in very good political health compared to the large English-speaking countries.

They are led by able, serious people – in sharp contrast to Boris Johnson’s ‘managed chaos’ (this week he stumbled over basic economic concepts of ‘real wages’ and productivity), and who at least in the cases of Macron and Draghi have visions of what they want to achieve.

In addition, the three countries have in their own ways vanquished political extremists and have relatively healthy democracies. In contrast, with trials of perpetrators of the January 6 attack on Congress still ongoing, 56% of Americans think that their democracy is under attack according to a survey for CNN.

If my rosy view of Europe is correct, one looming question is whether (assuming Scholz becomes Chancellor) the leaders of the three large countries can work together and more specifically what are the issues upon which they might choose to collaborate.

The obvious area is economic growth and the stalled plan for a broad fiscal stimulus to relaunch Europe’s recovery. Each leader has a personal interest in the more efficient workings of the euro-zone financial system, and this may well spur capital market and further fiscal reform. Germany has a substantial deficit in terms of required investment in energy, telecoms and defense investment. At the same time, European foreign policy will still be driven by the French, with a more active contribution from Rome.

Another area, which is again becoming topical given the recent judgment by Poland’s top court that the Polish constitutions supersedes EU law, is to clarify further the idea of European values, and to take tangible actions and exert political force to ensure that the likes of Hungary adhere to them. It is not inconceivable that the great test of the political will of the ‘triumvirate’ will be to prune the EU down to 26 nations and force the ejection of Hungary, and in so doing, in Willy Brandt’s words to ‘dare more democracy’.

Have a great week ahead,

Mike

Out Foxed

In 1933 President Franklin Roosevelt appointed Joe Kennedy, patriarch of the Kennedy clan and father of the future President, to be the first head of the SEC (Securities and Exchange Commission). The odd, and subsequently effective rationale for this was only a fox could ‘out fox the foxes’. Kennedy was well known at the time as a speculator and to put it politely ‘entrepreneur’. When he left the SEC in 1935 (by which time his net worth was close to USD 4 billion in today’s terms) his work there was widely praised, and he even made the frontpage of Time magazine.

What is worrying today is that if Kennedy took the path from ‘rogue’ to regulator, the events of the past week suggest that the heads of many of the important institutions are taking the opposite path. Note that in the past week, two of the more experienced regional federal Reserve chiefs (Eric Rosengren in Boston and Robert Kaplan at Dallas) have ‘retired early’ following the revelation that they engaged in large security transactions in recent years.

I am surprised that this news has not received greater attention, especially when seen in the context of reports that Fed Chair Jerome Powell has a very large securities portfolio (reportedly over USD 50mn) and reports that senior American politicians like Nancy Pelosi actively trade securities and derivatives. More than any time in history, the Federal Reserve is the key to the path of the bond and stock market moves (at record high valuations by the way), and the fact that senior members of the Fed’s monetary policy committee have traded speaks less to complacency and more to weak standards and vastly diminished credibility.

Add to this the scandal embroiling the head of the IMF Kristalina Georgieva (whilst at the World Bank she allegedly manipulated the findings of a study to show China in a more favourable light) and the ongoing travails of WHO chief Tedros Adhanom, and a picture build of rudderless, increasingly corrupted world institutions of the twentieth century.

One might say that this has always been the case. Take the IMF for example – the three former heads have been involved in scandals – Christine Lagarde (the Bernard Tapie/French government), Rodrigo Rato (fraud and embezzlement) and of course Dominique Strauss Kahn.

Then in Europe, where few if any central bankers have any banking or markets experience and thus a penchant for trading (thankfully), senior ECB officials Philip Lane and Benoit Coeuré have ‘steered’ hedge funds and investment banks towards the ‘correct’ views of ECB policy in private meetings, thus helping those investors make large profits.

So, if the IMF has form in the area of corruption, it has not been the case for the Fed. I cannot think that recent Chairs (Yellen and Bernanke) would sanction securities trading by senior colleagues. In my view, and consistent with the overall ‘Levelling’ thesis, we are at a point in history where evidence of the degradation and obsolescence of the institutions of the 20th century is piling up. Within that thesis a number of things are increasingly clear.

First, as the world becomes multipolar, it is now nearly impossible for international institutions like the WHO, WTO and IMF to straddle the breakdown in relations between China and the US, and the competing demands that each country will place upon them. As a result we will likely see more regional institutions develop than international ones – the Asian Development Bank being an example.

Second, in a hyper financialized world it seems that the trade-off between good governance, probity and exemplary leadership on one hand, and large financial rewards is just too much for some.

Third and relatedly, one of the issues that is increasingly debated in the corporate and venture capital world is the need to attract and keep top talent. If world institutions are to attract people of experience and quality (which seems to have been a problem at the IMF for example) then they will likely have to change remuneration structures (Mark Carney’s tenure at the Bank of England is an example).

For the time being, these scandals raise doubts about the operational capability and credibility of the institutions I have mentioned. At a crucial point in the monetary cycle, when inflation is showing signs of a durable pickup, the strength in depth of the Fed is severely weakened, and in my view opens the risk of a monetary accident. Jerome Powell’s prospects of being reappointed Fed Chair have taken a knock, and Lael Brainard may well take his place.

With regard to other institutions – the IMF in particular, it has changed its policy view so many times in recent years and has repeatedly been shown to have adopted the wrong policies, that it is near defunct. I feel that there is too much policy time and energy spent on chattering about reform of bodies like the WTO (according to Bloomberg, the new WTO head has already threatened to resign), which at this stage are beyond reform in that they cannot be repurposed to address the challenges of the 21st century.

We should rather spend time thinking about the problems that lie ahead and think about the rules and institutions that can be crafted to tackle them, in the context of a world where the large nations at least, are unable to cooperate. It’s a job for game theorists, historians, systems experts and psychologists, but not central bankers. 

Have a great week ahead,

Mike