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

Fantastic Corruption!

Cameron explains corruption

In May 2016, at a summit on anti-corruption the then British Prime Minister David Cameron said in hushed tones to Queen Elizabeth, ‘We’ve got leaders of some fantastically corrupt countries coming to Britain… Nigeria and Afghanistan, possibly the two most corrupt countries in the world’.

A month later he lost the Brexit referendum and the UK has been in a state of chaos ever since.

Nigeria most likely had little hand in Brexit, but the complacency of Cameron did. So too, according to last week’s Commons Intelligence and Security Committee’s report into Russian influence in British politics, did the openness of the Cameron government (and others) to the generosity of Russian donors (fourteen ministers in the Johnson government, including six cabinet ministers have accepted donations from Russians living in the UK).

Britain, which for so long and in the eyes of so many, is the country that has epitomized the rule of law (for instance see Tom Bingham’s book of this title). Its lackluster response to financial and other incursions by Russia, the politization of policy (Cummings v Whitehall) and the faulty response to the COVID 19 crisis have contributed to the view that the robustness of institutions and the rule of law are in decline in Britain.

It is not alone. Last week in an interview with CNN House Speaker Nancy Pelosi declared that the stock market was ‘rigged’, and that this might not be such a bad thing. For a country whose value set is based on capitalism, this is an astonishing admission, though less surprising in the context of the vandalization of the rule of law and institutions in the USA by the President. Most US Presidents have underlined the importance of the rule of law, from Eisenhower to Kennedy to Reagan, but not Donald Trump.

Like Downing Street, the change in moral tack at the White House points to the testing of core values in the two countries whose empires formed the basis of globalization (Britain in the 19th century and the USA in the 20th century), and in that respect, is yet another crack in globalization.

Policy makers in each country should play attention to the elaboration of the link between the erosion of the rule of law to the end of empire by Edward Gibbon in ‘The Decline and Fall of the Roman Empire’. More recently, there is plenty of evidence to show a link between economic growth, financial stability and the rule of law across countries.

If politicians in say the UK, or any other European country for that matter, are happy to take donations from citizens of Russia and China, it is harder for them to claim the moral high ground over China in foreign policy. It is equally problematic for US Secretary of State Mike Pompeo to travel the world looking to build an alliance of democratic countries against China whilst the rule of law is undercut in the US.

If the idea of the rule of law is going out of fashion in Washington and London, it is gaining some allure in Brussels.

Much has been made of the hard won result of last week’s European leaders’ summit (it was the second longest ever, only 25 minutes behind the Nice summit in 2000) in the sense that it has created fiscal capacity for the EU. While the classic division between fiscally conservative or ‘frugal’ countries and those like France and Italy who are fiscally indulgent was on display, a new fiscal fissure is opening up.

The agreement reached last week introduced some (yet mild) conditionality around the rule of law in terms of how it binds aid to EU members (the likes of Bulgaria, Romania and Poland are on the minds of Brussels). Though no sanction has yet fallen on the Viktor Orbans of the world this move is part of a new trend where European values are going to play a more prominent role in political discourse (seven of the top ten countries in the World Justice Project report on Rule of Law are EU states).

In the future, collaboration will be done less on the basis of geography and more on the basis of shared values – this might mean that bodies like NATO and the EU may lose rather than gain members.

It also means that the nations of the ‘old’ world need to realise that their economic and political advantage comes from the rule of law, and that the current race to the bottom in terms of practice of the rule of law, is self-defeating.

Have a great week ahead,

Mike

The Restoration

Team Restoration

The middle of the 17th century was an extraordinary period, especially for political and institutional innovation. The Treaty of Westphalia in 1648 gave us the nation-state, books like Hobbes’ ‘Leviathan’ were produced and in England the first expressions of popular constitutional democracy were aired. The tumult of the period was dampened with the return of King Charles II to England, in what was called ‘The Restoration’, which is a phrase that comes to mind when I think of Joe Biden’s Presidential hopes.

To start with, I won’t try to map the US in 2020 on to Europe in the late 17th century, save to say that both periods are marked by a sense of a ‘world turned upside down’.

However, the notion of an American Restoration is appealing in the sense that a Joe Biden Presidency would restore the thread of Democratic policy (through Obama to Bill Clinton), and very importantly would restore the competent workings and full staffing of institutions like the State Department. The idea is that the American machine of state (I wrote about the French one last week) would once again purr into action, and American credibility would be restored. The question for Biden, the Democrats and America, is whether he can accomplish more than ‘a Restoration’.

With Biden now well ahead of the President in most opinion polls on national and state by state levels, and Donald Trump sacking his campaign manager last week, the prospect of a Biden Presidency is now very real, though financial markets it seems are not yet pricing this in.

The success of Biden’s campaign and the tenor of his potential presidency will rest in good part on the extent of the economic damage ahead. If high unemployment and bankruptcies are a reality into the presidential debates in September and October, the tone of policy will tilt much more towards social justice (a topic where both Bernie Sanders and Elizabeth Warren are very comfortable).  

A Biden White House would likely focus much of its stimulus effort on infrastructure, particularly so in the ‘green’ economy. What is much less clear is the extent to which they would consider rejigging the tax system to place a greater tax burden on wealthier Americans and corporations. This may well be teased out in coming months. I also expect that foreign policy under Biden will be much more assertive, especially so towards Russia and China.

Biden’s next step is to choose a running mate. My judgement is that Biden will choose Kamala Harris as his VP, not least because she has a track record in policing and justice, which is one policy area which the Trump campaign is likely to amplify. Other VP candidates like Susan Rice may suffer from the fact that the Biden team already has a very well stocked foreign policy and security bench.

For his part (and provided he doesn’t drop out of the race!) Donald Trump will inevitably contest the election in a divisive way. Trump’s key weapon over Biden is his social media and network TV reach, and here he can do plenty of damage (to himself also).

There is plenty that he can agitate on – such as contesting the logistics of the election (i.e. postal voting), to stoking tension of topics that resonate with some voters – China, defunding police forces and the prospect of more economic stimulus. He may even claim credit for a COVID-19 vaccine, should it materialize before November.

However, such an approach may not win him a second term as it may merely serve to reinforce the views of the 40% of Americans who think ‘he is doing a good job’. Moreover, with a record number of women now contesting elections for Congress, and more states reacting in a constructive way to racial and other inequalities, the broad socio-political tide may be turning against Trump.

It is now widely recognized that Trump has vastly diminished America – it is financially weaker, its soft power is squandered and its institutions are less admired. He may now also wreck the Republican Party.

Should the Democrats take control of the Senate, it is not impossible that the rump of the Republican Party might split into those who share Trump’s political convictions, and those for whom he was a convenient political force. The ‘convictionists’ could form a harder right wing party, while the ‘conventionists’ might repent and try to rejoin the mainstream in the fashion of the country club Republicans of the Reagan era, led potentially by someone like Liz Cheney.

For their part, the dilemma is what tone to strike across states so that they take back the Senate. A mild ‘re-unite’ America approach is the most likely one, at the expense of the muzzling of the likes of Bernie Sanders. Once in power, the Democrats will be more interesting in that they feel more comfortable following the tack of the likes of Elizabeth Warren, and more emboldened in reinforcing regulation in areas like corporate governance and environmental protection.

A scenario that (according to polls today) brings about an end of Trump politically, cripples the Republican Party and reinstates the Democrats may well restore stability to America, but my worry is that it won’t change it, and much less so may postpone some of the radical policy that is needed to truly revitalize America.

The manifest social tensions, political stasis, and extremes in wealth/inequality as well as declines in human development indicators point to the need for more than a simple restoration.

Have a great week ahead,

Mike

Dans l’Ombre de Sully

Sully!

I confess that on more than one occasion that I have joked to French friends that ‘Sully’ (Maximilien de Bethune, Duke of Sully) the chief minister of France for twenty years around the turn of the seventeenth century is an ancestor of mine. Most are unimpressed, and American friends suggest I would be better off being related to the other ‘Sully’ (Captain Chesley Sullenberger the US Airways pilot who famously landed his plane on the River Hudson).

Sully, the elder that is, is worth pondering for two reasons. First, he was one of the longest standing holders of the office of prime (chief) minister of France, and secondly, he was the architect of some of the early, institutional apparatus that forms France’s highly centralized system of government. Both of these elements are now in focus with the replacement of Edouard Philippe as prime minister by Jean Castex.  

With many other senior ministers still in place, the removal of Edouard Philippe is a political statement by Emmanuel Macron that he and he alone is the captain of the ship of state, with M Castex in the boiler room running the complex machinery of the country. For his part, M Philippe, now mayor of Le Havre, may spend his spare time writing (check out ‘Dans l’Ombre’ written with Gilles Boyer) and cultivating a network of regional support that might equip him to challenge Macron for the Presidency. If so, it will be an enthralling battle.

However, there are other reasons to focus on France, not least next week’s 14th July celebration.

From a European point of view, a lot rests on the collective views and behavior of the French government – which in a country with relatively tame inequality, is one of the most elitist and homogenous in terms of personnel and thought process. There are maybe three challenges to watch.

The first is Europe. With the French-German political engine now whirring again, the approaching end of the Merkel era and the long running absence of a strong German foreign policy, Quai d’Orsay will be the driving force behind EU foreign policy. This is a positive given the policy energy of Macron and the unambiguously pro-European stance of his administration. It will be problematic in the sense that France, as Europe’s military power and a UN Security Council seat holder, also prosecutes its own foreign policy – notably on Russia and Libya.

In this way, France must decide whether it is what I’ll call a ‘great’ country or a ‘strong’ country. ‘Great’ countries have had or desire empires, they have nuclear missiles and soldiers stationed abroad. Their foreign policy is grand, ambitious and causes headaches for other nations. The US, China, Britain and Russia fall into this category. France is easily a peer of theirs.

‘Strong’ countries are the poster children of the post-coronavirus era. They are generally well lead, but not bumptiously so. They value public goods like education and healthcare, have well thought out tax and welfare systems, and are resilient to shocks. Norway, Singapore and New Zealand are in this category, and France might wheedle its way in too if we consider factors such as its state lead approach to innovation.

To draw these strands together, France’s challenge is to make Europe more ‘great’ and itself more ‘strong’, especially in the sense of opening itself up to and integrating more diverse influences. Corporate France is an example, very few women and few foreigners run French companies – unlike say the UK. This is just one rigidity in the French system. Another is a groupthink across the state on the Cartesian need for uniformity. This is dangerous when applied beyond French borders on the European stage.

The mantra that there should be a common fiscal policy amongst nineteen very different euro-zone countries risks handicapping many and robbing the system of the flexibility it needs in the context of a common monetary policy. Moreover, as a mantra it allows policy makers to be blind to the reality that mounting debt loads and perennially weak fiscal deficits have made the fiscal rules of the euro-zone meaningless, to the point that they are replaced by the ‘rule-all’ policy of the ECB.

If Emmanuel Macron is a revolutionary politician, as he tells us, then his economic policy must do at least two things. The first is to reduce debt – here the sale of state assets is perhaps less unpopular than cutting state spending. The second, more important one is to cultivate the narrative that economic growth is positive and necessary. France’s lack of growth (trend growth over the last ten years is just above 1% ) is perhaps the one thing that distinguishes it from ‘great’ countries (e.g China, US) and ‘strong’ ones (i.e. Ireland, Singapore and New Zealand. Macron’s policies to help entrepreneurs for example are meaningful, though underestimated beyond France. He now needs to redouble his efforts.

The Duc de Sully took twelve years to turn around the French economy (1598-1610), Emmanuel Macron has two years left to secure a rebound.

Have a great week ahead,

Mike

Seriously Stimulating

What would Keynes think?

In last week’s missive I referred to the ‘coup de whisky’ monetary stimulus enacted by the Federal Reserve in 1927, which kick started the market boom that later ended in a resounding crash.

This week I want to focus on the fiscal side. With the US employment assistance program running out at the end of July, new prime ministers/cabinets in Ireland and France, many governments will be turning their minds to the construction of economic stimulus programs. Indeed in the last week, Italy and the UK for example have made headline grabbing announcements.

While Boris Johnson made much of a five-billion-pound building spree, I think that his government’s promise to give citizenship to three million Hong Kong citizens is the very best stimulus it could enact – if they come, the Hong Kongers will bring entrepreneurship, wealth, erudition and culture.

This cuts to the central dilemma in any post COVID 19 stimulus effort – should, in the context of already eye watering indebtedness, governments try to aggressively restart economies in as sharp a ‘V’ shaped recovery as possible, or should they try to remodel economies to the realities of the post COVID19 world. The fact that the virus has exacerbated and exaggerated many of the emerging faultlines in the world economy suggests that a far sighted rather than electoral cycle driven view is required.

In addition, a short-termist view is complicated by two facts.

First, there is a risk that many economies suffer credit crunches and bankruptcies as we move towards September (anecdotally many businesses, shops, bars and restaurants I know are struggling but that might just be O’Sullivan curse). Without seeming like a monetary masochist, it is often better to allow this credit unwind to occur than to forestall it, and then to help entrepreneurs and business owners restart quickly.

Second, one practical economics lesson is that it is always easier to enact a stimulus program if your neighbours and trading partners are doing the same. For example, in the early 2000’s Germany was able to digest tough labour market reforms because its trading partners across Europe were all growing. In that context, Ireland is in a bind because two of its ‘neighbours’ and trading partners, the US and UK, do not have COVID19 under control. What is worse is that there is very little economic coordination between the large economies of the world, and this will complicate the overall stimulus effort.

The stimulus conversation in most countries will be coloured by references to Keynes, and to the word ‘multiplier’ or rather, the sensitivity of economic activity to different types of policy ‘boosts’. Yet, the accuracy of multipliers is not great, as the debate during the euro-zone crisis showed. With the world economy having had ten years of sluggish expansion and as such at the very late stage in the business cycle, overall ‘multipliers’ are likely to be low. This means that politicians need to think very carefully how they spend capital and what the intended effect is going to be.

There are a few principles to think of.

The first is the idea of a ‘quid pro quo’. As mentioned in a recent post, the phrase entered the lexicon of American politics through George H Bush, and then in the current President’s impeachment case. The notion of a quid pro quo should reign over policy interventions, in potentially, a range of ways that will produce a more sustainable and resilient economic model. Specifically, sectors or industries that are helped out are required to change their business models in return for fiscal and monetary help – these could be agriculture (more climate friendly), transport (better governance and management). 

A second factor to consider is the view that there needs to be a sense of building the economic model of the future under the steam of a stimulus – this approach would see money devoted to reskilling and work experience, and also on green technologies or industries that the state deems to be strategic or ‘of the future’. 

Here there is a need for the EU to stop and think, in two respects. There is too much time spent on how the Recovery and Resilience program will be distributed (loans or grants) and not enough on what it will be spent on. Also, there should be some coordination across national stimulus programs, so that they all point in much the same direction.

With Europe still in mind, one factor that has changed noticeably from the global financial crisis is the absence of an ‘austerity’ narrative. This is partly because austerity is now seen to have failed as a policy, partly because markets do not appear overly concerned at the largesse of government spending across Western economies (with thanks to central banks)

A third idea is that in addition to financial support, new growth oriented industries will also need the help of better ‘soft’ infrastructure to help them survive. What I mean here is that industrial ecosystems are as much enabled by regulation, standards and human capital as they are by capital.  A good example is the need for an overhaul of fintech and payments regulatory frameworks in the wake of the Wirecard scandal. 

While it is right that governments will want to support labour markets – and most European policy responses have done a good job here – they should stop and think before splurging cash on stimulus programs – the road to recovery will be a long one.

Have a great week ahead,

Mike

Lords of Finance or Sorcerer’s Apprentices

The Fed meets the Bank of England

In 1927, in the context of economic weakness, Benjamin Strong the President of the New York Federal Reserve suggested to a counterpart in the Banque de France that a rate cut might give the stock market a ‘petit coup du whisky’. The subsequent rate cut set in train a fierce market rally which, boosted by margin debt, ballooned into a stock market bubble. 

According to Liaquat Ahamed’s superb book ‘Lords of Finance’ Federal Reserve officials had considered the ‘coup de whisky’ to be the Fed’s ‘greatest and boldest operation’. Yet, the collapse of this stock market bubble was one of the factors that set in motion the Great Depression.

By comparison to the actions of today’s Fed, Strong’s ‘coup de whisky’ is insignificant when compared to the huge and sustained quantities of monetary morphine that the central bank has dispensed in recent years. The near vertical rise in central bank balance sheets in the aftermath of the coronavirus crisis has suppressed market volatility, but, like morphine, it cures few underlying economic illnesses. In fact, with the echo of the Great Depression in mind, it may eventually make them worse.

With the Nasdaq index pushing through all-time highs at the start of last week (and now retreating a little), valuations becoming very stretched and an increasingly well documented retail investor trading frenzy occurring, we are entitled to ask where and when the consequences of aggressive central bank activity will lead?

While the official line at the Federal Reserve and other central banks regarding asset price bubbles is that asset bubbles are hard to identify and harder still to burst in a controlled manner, there are at least two risky side-effects of current policy, and then two potential endgames.

The first risk relates to the consequences of the ‘stupefaction’ of the political economy through monetary policy. For instance, politicians, such as the once fiscally conservative Republican party, seem to care less about rising debt and deficit levels in the face of central bank asset purchases.

In Europe, capital markets union, the consolidation and rebuilding of the banking sector, and more active and sophisticated regulation of fintech and payment systems are half made projects that lack urgency. In general, central bankers seem to focus too much on liquidity, than on the plumbing of market and banking systems.

Another side effect is inequality, in multiple forms. Wealth inequality in the US is the most pronounced since before the Great Depression. Another form is central bank inequality. The monetary aggression of the Fed and ECB makes life difficult for other smaller and less activist central banks, through the resulting fluctuations in their currencies for example. In particular in recent years, the likes of the Norges Bank and Riksbank have struggled with the side-effects of ECB policy.

Central bankers are known to be sensible, rational people and in the face of mounting evidence of the distortions of their work and the hint that they are losing their independence, we might expect them to signal an elegantly coordinated end to extraordinary policy. The opposite is likely to be the case.

The great risk to financial stability is that central bankers continue to internalize the benefits of quantitative easing, to the extent that they go into monetary warp factor and break markets. The Bank of Japan, which now owns nearly 80% of the Japanese ETF market, is a candidate here, given the store it sets by monetary activism and discussions it has conducted on monetizing government debt.

Monetizing government debt is not a free lunch, and if for argument’s sake it were executed by the Bank of Japan it could trigger broad currency volatility, a pensions crisis and a very confused credit market. Risk cannot be made to go away, it is simply distributed by markets and central banks that intervene in this process risk a ‘nuclear’ level financial accident.

The second related risk is indebtedness which before the financial crisis was – in terms of the aggregate world debt to GDP ratio – approaching levels not seen since after the Second World War, and now may be on course to reach levels comparable to the aftermath of the Napoleonic Wars. Low rates make this debt load manageable but a credit cycle downturn may result in a market unwind that even the Fed and other central banks cannot forestall. The endgame here may be a severe recession, or an broad debt restructuring conference.

Whether they are ‘Lords of Finance’ or ‘Sorcerer’s Apprentices’ today’s central bankers have contorted the financial world in an effort to stave off another Great Depression, and now having done too much, risk going full circle.

Have a great week ahead,

Mike

Saving the UN from the John Boltons

John Bolton doesn’t like the UN

In a week when John Bolton has revealed the ‘true’ workings of US diplomacy, North Korea cut its border infrastructure with South Korea, Israel prepared to annexe part of the West Bank and when at least twenty troops died in a high altitude confrontation between India and China (regular readers might recall my May 16th post ‘Shemozzle’ on this), one of the few pieces of geopolitical good news last week was the election of Ireland and Norway to the UN Security Council (they take their places in 2021).

Regular readers will also know that I have a bias to small, advanced states in general, and to Ireland in particular, and I am particularly proud of this news and the efforts of our ambassador to the UN, diplomats and politicians.

I am tempted to reflect however, that in the next few years, there will be few places as charged, and as tested, as the Security Council. Indeed, that John Bolton was previously as US ambassador to the UN and wants to abolish it (he declared that if it ‘lost 10 stories, it wouldn’t make a bit of difference’) highlights the strains on the organisation. Indeed, as the sands of world power shift, it is not inconceivable that the UK be asked to give up its permanent Security Council seat in favour of India and that France is similarly requested to surrender its seat in favour of the EU.

The tenor of the events debated at the Security Council in coming months will depend heavily on the flashpoints mentioned above, the outlook for Taiwan, and whether Donald Trump manages to stay in power. The addition of Ireland and Norway to the Security Council is novel, and newsworthy in that in a world of mind-numbing policy uncertainty, they are positive contributors to the UN (i.e. peacekeeping) and good examples of policy resilience, especially so in the context of COVID-19.

While it is not the job of members of the Security Council to reform the UN itself, there is a need for this world institution to be enlivened. The ongoing debate on this might focus on the following points.

The first point concerns organisations under the UN umbrella such as the WHO (World Health Organisation) and World Bank. Here, one suggestion is to physically relocate bodies like the World Bank to Africa, which is the continent that needs it most. In addition, some of the research efforts of the World Bank, IMF and WHO should be repurposed and focused on a handful of larger emerging countries with positive demographics, emerging consumer tastes and yet underdeveloped financial and social welfare systems. These countries collectively (e.g. Indonesia, Vietnam, Nigeria, Bangladesh) constitute the next wave in human development and wealth creation, and need careful, practical policy advice on the path ahead.

Then the UN will have to deal with new forms of war, one of which is cyberwarfare and where there is a need for a credible, coherent set of ‘rules of the game’ that encompasses governments, technology companies and private contractors. In the past week there have been cyber-attacks on financial institutions in the US, and a large scale one on institutions across Australia, and in the recent past the UN has suffered severe cyber-attacks.

There is already a policy discussion on cyberwarfare at the UN, and its Secretary General spoke publicly on the topic last November. There is room for the UN to think more clearly about ‘cyber peacekeeping’ in the sense of adapting its current peacekeeping framework to the internet.

The UN may also have to deal with the side-effects of new forms of military tactics. In his excellent book ‘The Dragons and the Snakes’ David Kilcullen describes in detail the tactics used by the likes of Russia for testing and agitating the borders of neighbouring ‘Western’ countries, like Norway. It strikes me that, in the light of India’s closer ties to the US and ambitions to host global supply chains, this is also China’s tactic. It is not war but controlled, thinly disguised, conflict, that in the case of the two most populous countries in the world could have adverse consequences.

A further challenge, that has become more evident in the fallout from the coronavirus crisis, is what are international public goods (the UN debated this back in 2006) and how are they best built and allocated. We could argue that in a hyper financialised world, cheap money is a global public good though I suspect this argument will not find much favour.

A better starting point, especially in the light of the debate on the future of the WHO, is to ask whether clear healthcare advice and health related education are public goods (I think so) and whether vaccines for pandemics like the coronavirus should be global public goods (which if this is to be the case would drastically change the way they are researched, produced and manufactured).

A final thought for the UN, and a provocative one, is to return to another quote from John Bolton that ‘There is no United Nations. There is an international community that occasionally can be led by the only real power left in the world, and that’s the United States, when it suits our interests and when we can get others to go along’. How will the UN cope with the demise of US foreign policy?

Have a great week ahead,

Mike

The Madness of Crowds

Bubble trouble

We are not yet half way through the year and, to put it mildly, quite a lot has happened. One very powerful lens with which to view 2020 so far is through the notion of crowd behavior – crowds rushing to buy toilet paper, crowds obediently dispersing into lockdown for two months and crowds in a frenzy to buy penny stocks in the US.

There is a growing literature on the behavior of crowds or how collective consciousness works, but some of the older texts are still worth a read. Gustav Le Bon’s ‘The Crowd – a study of the popular mind’ written in 1895 is one, and a much older one which I recommend is Charles MacKay’s ‘Extraordinary Popular Delusions and the Madness of Crowds’ written in 1841. It is a vivid history of asset price bubbles going back as far as the time of the Crusades, and MacKay, having published it likely hoped that people would learn from it and not repeat mistakes of the past.  

MacKay would have been alarmed though not surprised at some market behavior seen this year, an initial wave of euphoria pushing stock prices higher in February as the coronavirus crisis was unfolding, and then recent aggressive buying of bankrupt companies like Hertz and Cheasapeake Energy, and the tenfold rise in the share price of Chinese construction company FANGDD because its name resembles the FAANG acronym (its stands for Facebook, Amazon, Apple, Netflix and Google).

Since the onset of the coronavirus crisis, the number of retail brokerage accounts at onlne broker Robinhood has nearly quadrupled (there is a Robinhood Tracker app which shows what stocks are most in and out of favour with the Robinhood crowd), with other brokerage sites also seeing a rise in accounts. Apparently, half of those who open new accounts have never invested before. The only rationale for such behavior is that having bought a stock like Hertz, a ‘greater fool’ will come along to buy it at a higher price.

There is a strong sense that some stimulus cheques, and the effect of the Federal Reserve’s huge liquidity injection into markets are having the effect of encouraging reckless speculation.

If this is a cautionary tale for the Fed, its Chair Jerome Powell showed little sign of acknowledging it in his recent press conference.

With the US stock market near all time high valuations, the Fed openly risks creating an asset bubble, further deflating its own credibility and independence, not to mention spurring inefficient use of capital in the midst of a deep recession. The Fed is also guilty of reinforcing the crowd behavior or groupthink amongst central banks that blind buying of assets constitutes effective monetary policy.

If the Fed and US policymakers have enabled bad crowd behavior, what is more interesting are examples of positive collective behavior, the most remarkable of which is the way in which hundreds of millions of people have adhered to lockdown rules.

Some of the early crowd behavior during the crisis illustrates how crowds follow narratives based on short-termism and fear – such as the toilet paper mania of March – there is also a need to focus on the wisdom of crowds.  A good recent example is the way that the majority of race related protests in the US, and the reaction of the police to them, have transformed from violent to peaceful protest.

I hope that in the future more behavioural and political scientists will dig more into this area. In this respect, one theme to emerge from the crisis is the sense that ‘country resilience’ matters in coping with crises. Amongst the components of this resilience are good education systems, credible institutions, clear and fair laws and a high level of trust across society. I suspect, without having yet looked into any evidence, that high trust societies tend to produce ‘wise’ as proposed to ‘mad’ crowds.

‘Mad’ crowds do not need to be preordained. One noteworthy research project that has come to my attention recently is the work of Gary Slutkin’s Cure Violence project (cvg.org) that seeks to break down the transmission of the culture of violence through communities (and by extension ‘crowds’). Another which I have mentioned here before is the way in which social media is being used to ‘crowd think’ laws, charters and constitutions (thegovlab.org). As the desire for political change grows across many countries, crowds will be used in more productive ways.

Have a great week ahead,

Mike

Is inequality a part of the American Dream, or its end?

A quote that has been rattling around my head recently is ‘aside from the moral case against it, inequality above a moderate level creates a kind of society that even crusty conservatives hate to live in, unsafe and unpleasant’. It comes from a 2004 paper entitled ‘Is globalization reducing poverty and inequality?’ by LSE Professor Robert Hunter Wade.

It has come to mind for obvious reasons – namely the behavior of crusty conservatives in America in the face of stark inequalities across race and class, and the risks that extreme inequality poses to the US.

While on one hand 43 million Americans having now claimed unemployment benefit and on the other, the ratio of the size of the US stock market to GDP (one of Warren Buffet’s favourite indicators of ‘value’) is the most stretched ever, the topic of inequality should rise to the top of the US political agenda, with the death of George Floyd a very grim expression of this.

In the US, and in some emerging countries, inequality, in different forms is rife. Much has been written on income inequality (Branko Milanovic’s work is to be recommended) and there is also increasingly good data to show that wealth inequality is the most stretched in close to a century in the US, and the likes of Russia. What is less widely debated publicly are the other ways in which inequality expresses itself.

Health is one area. Angus Deaton and Anne Case’s work is now well known (he won the Nobel Prize) and shows the deterioration in health conditions, especially those relating to mental health, for middle-aged white men and women in the United States. The mortality rate for this cohort has increased sharply owing to drug, opioids and alcohol poisoning, suicides and diseases such as cirrhosis of the liver. Groups with lower levels of education saw a sharper rise in mortality. The coronavirus crisis reinforced this trend.

Another more detailed example of health-care inequality is in dental care. Mary Otto’s book Teeth shows the startling differences in dental health across social classes and reports that they spring from differences in education, diet, and upbringing. In her book Otto tells of a boy who died when a tooth infection, undetected because his parents had no dental-care insurance, spread to his brain.

Technology is another factor that may help cement existing inequalities. For example, in her book Automating Inequality, Virginia Eubanks describes how automation of welfare services through the growing use of algorithms to sift welfare recipients, and in areas like medical insurance assessments, can lead to institutionalized inequalities (the algo- rithm throws out the more needy welfare applicants) and injustice. She describes a regime of data analytics that, through design or error, denies assistance to those in poverty, with low education levels or poor computer literacy, or with a history of mental health issues.

Another example of technology-driven inequality comes from Joy Buolamwini, the founder of the Algorithmic Justice League, whose research initially discovered that facial recognition software was much more accurate at recognizing white faces than black faces. Inaccuracies in algorithmic-based identification can translate into denial of access to social welfare, or misclassification of an innocent person in criminal records.

There is likely much more to describe inequalities that disadvantage according to race, class and sex for instance. The important issue is what is done about them. In the context of the US, the first task is to recognize that inequalities do not stem from globalization but rather how individual countries manage it. The coronavirus crisis illustrated this. A  common problem was dealt with in very different ways with disparate results.

Small, advanced economies like Sweden, Ireland and the Netherlands are amongst the most globalized in the world and have relatively well contained levels of (post-tax) income inequality for example. In addition, they are sources of policy ideas on how to combat various forms of inequality.

To understate the matter, I do not expect the current administration to tackle inequality. Indeed the persistence of deep inequalities following the eight years of the Obama presidency shows how entrenched it can be, and I am not sure that the Biden team will make an immediate impact on inequality – to do so would require a radical change in corporate taxes (higher), federal spending (higher) and regulation (especially of tech).

To that end, the persistence of an overly accommodative central bank, a two tiered health system, a technology sector that hoovers up the gains from innovation and a ‘star’ takes all approach in the banking, sports, media and tech industries point unfortunately towards ongoing inequalities in race and class.

In turn, as the election of Donald Trump has shown, the persistence of inequality, will produce radical political choices. My guess is that America has not seen the end of political volatility, and that increasingly new blood, and new parties will enter the political scene.

Until then, America will remain divided. To return to Robert Wade’s quote, crusty conservatives don’t get it. On Friday Fox News displayed a disgraceful graphic of the performance of the stock market in periods immediately after the king of a black man (From Martin Luther King to the recent death of George Floyd).

Have a great week ahead,

Mike