Ne vous mêlez pas du pain, II

I will not forget the moment I realized that the COVID epidemic was upon us, as it spread from China, then through Italy and the rest of Europe, and the lockdown came upon us. At the time I thought the lockdown might take two weeks, but in effect it has lasted two years (so much for my forecasting ability). That period has done so much to alter societies, economies and our outlook on the world. To a large extent, it has also scrubbed away some of the trends and memories of the immediate pre-COVID period.

Looking through my notes this was a period of very unusual strength in markets and economies – the stock market kept pushing new highs on near record low volatility, whilst the global economy was coming to the end of the longest expansion in modern economic history. There were, however, signs of distress under the bonnet.

In mid to late November 2019, I wrote two notes entitled ‘Ne vous melez pas du pain’ and ‘Demonstration Contagion’. In one, I flagged the sound advice that Robert Turgot, the 18th century French economic thinker and administrator gave to Louis XVI regarding food prices and unrest. It was good advice, which the King did not heed.

In the other, I highlighted ‘a remarkable outbreak of protests across a range of countries – from riots in Honduras, to ongoing tension in Hong Kong to climate related demonstrations in India’. At the time, the number of Google searches on the world ‘protest’ was at a five year high.

Granted the ‘hiatus’ of the coronavirus the question that I want to pose is whether, with inflation barreling forward at multi decade highs, unrest and discontent return (recall that some weeks ago we wrote that high inflation is a gift to populists) to break the general obeyance of the coronavirus period, and what kind of policy response this begets.

As context, for example, in the UK post tax incomes have dropped by 2%, the biggest fall since 1990. Housing affordability in the US is at extremes, and in parts of Europe inflation is out of control. So, in general we may be confronted with a world that, for some time, executes policy for political reasons, very much against the strictures of the textbooks.

Here are some thoughts on the likely fallout.

First, I can see a situation where central bankers face derision (or even more derision as some cynics might have it). As we noted last week, Jerome Powell’s Fed has got the inflation call badly wrong, and individual governors have demeaned the institution through their personal trading.

In Europe, the ECB deserves especial attention. Their record on inflation and rate forecasting is so appalling it is dangerous, driven perhaps by the fact that very few of the ECB governing council members have any experience of industry, finance or investing – occupations that might otherwise condition people to change their minds when proven wrong. If you take a peak at the photos of the ECB governors it a strikingly homogenous group, though even less diverse in the way they think and act.

The tardiness of central bankers in combatting inflation means that for the next year, households will face rising rates, high prices and a negative wealth effect. This cocktail should be enough to turn public attention towards the Fed and the ECB tower in Frankfurt. In Europe an added element of complexity is the divergence of growth and inflation across euro-zone countries, and the unwillingness of euro-zone central banks to use macro-prudential policies to rein in inflation. In time we will also see central bankers dragged before senate/parliamentary committees to explain why they have allowed the inflation genie to escape.

As central bankers grow increasingly uncomfortable under the glare of public opprobrium, politicians may decide to ride heroically to the rescue of households. For instance, in the past few day’s governments in Ireland, the UK and France have issued compensation payments to help people pay energy bills. One estimate I have seen suggests that with this ‘cushion’ the effective rise in electricity prices for French households is only 4% compared to an underlying 45%. When we recall the Gilets Jaunes (a movement triggered by higher fuel prices) and the coming presidential election in France, the logic for such a move is clear.

The risk is that these measures simply sustain inflation and create a greater dependency on governments.

Another, more inventive avenue may be a re-appraisal of fiscal policy broadly in the sense that it can be used is break down bottlenecks in supply chains and in ownership structures. Here one important outcome from the ‘inflation crisis’ may be a greater policy focus on breaking down monopolies in industry and consumer goods, concentrations of ownership in property markets and an increased investment in critical industries like semiconductors.

In the meantime, markets are shifting to the next phase of the ‘inflation’ trade. With equities having had a very sharp initial sell-off, the worry now is that credit risk begins to rise – this is dangerous because it translates directly in the real economy and will continue to undermine other asset classes. Inflation may fall as this occurs, though for some time people will continue to pay ‘high prices’. When growth and wealth fall, there may be ever more discontent, and we might be back to 2019.

Have a great week ahead,


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