@Donthe Robber

Watch out

Donald Trump’s reneging of the Kurds in northern Syria, his cynical treatment of Ukraine and his weak ambivalence on the Hong Kong protest movement may fit the pattern of his usual behavior, but to those outside the US these developments cut away the moral, military and diplomatic backstops that the US has provided to rest of the world for the last seventy years.

These acts pull up the drawbridge on the old liberal order, and now set in motion a fragmenting world of ‘patriots’, as he might put it. Another four years will render this regression permanent, with many yet unseen, negative consequences.

While many Americans will be happy that President Trump is committing fewer resources to what are other people’s problems, they must also realize that the cost of this is the end to American exceptionalism – this will have long lasting implications for the dollar, US multinationals, the security of America and Americans, for American culture and even for basketball.

For those who care about these things there are several things that can be done.

To start, technocrats, former public servants or even ‘experts’ from the military, economic policy, diplomacy and human development led sectors like education, need to speak loudly and clearly about the damage being done to America’s credibility, its institutions and human capital. Jim Mattis for example, entirely missed the opportunity to do this with his recent book.

Then, moderate Republicans, who if they have a sliver of moral courage and an ounce of sense, must start to put the future of the US – at home and abroad – ahead of career expediency. As it stands, they are more supine than many of the emerging nation governments they disdain. The very least they can do is stop blocking the rule of law, and the cloaking of the transparency of government.

As this occurs, the President will fight back. His greatest talents are his ability as a gutter scrapper, and his instinct for how to caricature his opponent’s weaknesses. He flatters and bullies, belying his own foibles. What no Democrat, or Republican for that matter has done so far, is to match him in this respect. Some might feel it is beneath them but it is the only way to loosen his electoral base.

Whomever succeeds in taking on the President will need to show that @DontheRobber is robbing the future to prop up the scam that the present is ‘great’. Corporate tax cuts, an alarming rise in corporate and government debt and a fiscal deficit that is unusually large for an economy in expansion, have all boosted the economy in the past three years, to cripple it in the future.

Record levels of wealth inequality rob the public in general, and the next generation. Equally, a short-term focus on a damaging trade war is disturbing corporate investment and supply chains, while the lack of real investment in education will rob the economy of a key source of productivity. Blindness to the consequences of climate change will rob many of the President’s supporters of their livelihoods as we move into the 2020’s.

The trade agreement with China, yet to be finalized, is a fine case in point. It falls far short of the terms that had initially been proposed, doesn’t at all tackle the concerns corporate America had and leaves open too many points of uncertainty. To their credit, the Chinese have done very well here.

In politics, the modus operandi of the President and those who enable him is robbing public life of any vestige of civility and fraternity, and risking divisions that will carry through this century.

The sense that America, its social fabric and its economy, are being robbed is just one, clear way of encapsulating the consequences of current policy making from the White House. It is now breaking old conventions, alliances and economic relationships on a nearly daily basis, and the cost of this needs to be made tangibly clear to Americans, lest the country, like a real estate speculation gone wrong, is sold away to opportunists.

Have a great week ahead,

Mike

Open economics and hard decisions

Ada Smith would know what to do

Two related stories from the engine room of economics struck me this week. One was the underlining by members of the European Parliament of the lack of female representation on the ECB Governing Council and the other was the news that the Federal Reserve is broadening its hiring process to recruit more women and people with more ethnically diverse backgrounds, though disappointingly this initiative seems only to be focused only on research assistant roles.

Both stories tell us much about gender, diversity and decision making and the direction of the economics profession.

On gender, all of the research I have been involved in this area underlines a couple of themes, that good data on gender representation is still hard to get (my friend Richard Kersley’s ‘Gender 3000’ database is one of the leading datasets), and that better (gender) balanced teams and boards make better decisions (or is it that men only ones make more bad decisions?).

In that way it makes great sense for organizations and institutions to recruit women to professional roles, but these institutions also need to facilitate the upward progress of women. I have known many female colleagues who have suffered the tyranny of ‘flexi-time’ – working a four day week, suffering career ‘stigma’ for doing so, and ultimately having to work 20% harder.

As it concerns central banking specifically, there is a much broader question of diversity of thought. By the time a man or women, from any given nationality has made it through an economics PhD programme of a major US university (Handelsblatt carried a news item last week which showed that only 4 of the top 30 German speaking economists are employed in German universities), published in leading economics journals, gained a faculty place or worked in the Fed/IMF/World Bank system, they have become creatures of the system, increasingly losing the incentive and ability to question the status quo.

Very few have the courage to challenge orthodoxy. A good example was the address that Rajan Raghuram gave to the Jackson Hole Symposium in 2005 (‘Has financial development made the world riskier?’) where (as later outlined in his book ‘Faultlines’) he warned of the dangers posed by the mountain of derivatives that had been built upon the US housing market. The response to his speech was frosty to say the least, and for a time many leading economists castigated him (Larry Summers called him a Luddite).  

The tendency of major academic economics departments to ‘form’ economists is dangerous because the creation of group think in central banking has produced a habitual, backward looking approach to monetary policy that usually ends up producing asset price bubbles and economic imbalances (e.g. negative yields, broken banks).

One response to this is to call for ‘new economics’. A recent example is entrepreneur Nick Hanauer’s impassioned TED Talk on the need to change capitalism. While I have sympathy for this view, I do not think that we need new economic theories but rather a better mix of formal economic theory with other sciences, and generally a much greater focus on the science of decision making (the US military and many sports teams such as the leading teams in the Rugby World Cup are innovators here).

One avenue is to pursue much more of a ‘Santa Fe’ approach to economics (I am thinking of the Santa Fe Institute which fosters a cross disciplinary approach to policy and science problems). Within economics, economists and analysts may in the future be better served by taking more the approach of a sleuth than of an econometric modeler.

Specifically, they should employ a wider variety of skills, ferret out facts and use firsthand experience to better understand them, and be more wide-ranging in their choice of the factors they choose to study. For instance, anthropology and sociology can sometimes better help understand the behavior of bankers and markets than can finance theory. If the pendulum of the economics profession is swinging away from a modeling-based approach, better that it swings toward development economics, for instance, which very often requires a more granular appreciation of how policy formulation works in practice.

Development economics is also the field where can be studied the impact on economic growth of a relative change in the quality of institutions or in rule of law, simply by virtue of the fact that the potential incremental change in both variables is much larger in developing than developed countries. I

In more detail, the policies, actions, and actors that affect development in emerging nations are complex, both individually and in the ways they interact with each other. In the Trump/Brexit/ Macron age, politics and institutional quality are exerting a very significant role on markets and economies, and a multipronged, more bottom up approach may be required to open the black box of how policy decision making is undertaken, how it might be improved, and, as I discuss in The Levelling how politicians can make good use of it.

In that respect the ECB and Fed should focus on hiring more senior female experts, in areas like law, banking, psychology as well as those with experience working in large organisations. Christine Lagarde is both the exception and the role model here.

The last issue is decision making. Surely, with debt levels growing, human development levels receding and the climate warming, we need to better understand why policymakers are so prone to avoiding big decisions?

Have a great week ahead,

Mike

A World of Patriots and Dreamers

China marching on, obstacles ahead

Last week’s UN General Assembly reflected a number of emerging trends – the miring of public life in older democracies (US and the UK) in banality and controversy, and the flourishing of climate change as a mainstream political issue, are just two.

These trends are part of the fracturing of the old-world order, and pointers as to where the new order may lie. Underlying each of them is the contentious issue of how political debate is conducted.

One striking statement at the UN was President Trump’s remark that ‘The future does not belong to globalists. The future belongs to patriots’. Practically, coming from the leader of the world’s superpower it is another nail in the coffin of globalization, in addition to being an embarrassing conflation of the meaning of nationalism with patriotism.

One of the ironies in Trump’s many grand statements is the way they echo in China. In fact, China is well ahead of Trump in conceiving of how to put the ‘country ahead of the global’. A memorable example was the 2017 World Economic Forum when the Chinese leader Xi Jinping made a speech that claimed the mantle of globalization for China (from the USA).

The curious aspect of this is that while China is a large spigot in the world economy, it is one of the least globalized countries in the world (it ranks in the bottom quarter of nations according to my own measure of globalization). In his own way, Trump is reacting to this, but his crude view of China does not do justice to its history nor the amplitude of its ambition.

Well before MAGA (Make America Great Again) Xi Jinping coined the term ‘China Dream’ in a speech when visiting the National Museum of China in November 2012, having taken the office of general secretary of the Communist Party. The 70th anniversary of the founding of the People’s Republic which occurs next Tuesday 1st October, will bring this into sharper focus.

China’s view of itself in the future, or the Chinese Dream, is colored by past generations of economic and cultural greatness. Recall that at the time of the Founding Fathers, the United States was but an emerging, even frontier economy and that at that time China accounted for nearly 40 percent of the world economy. By 1950, 150 years later, America made up a third of world economy, and China’s share had shrunk to 10 percent.

Given this backdrop China wants to elevate itself to a position of economic power (perhaps regional dominance) and of policy power in Asia with its own regionally relevant rule-based order so that it is, at the very least, not subject to the domination of Western countries and institutions (the film Amazing China, to be found on Youtube,gives a sense of this and of what is ahead).

China’s rise over the past thirty years has not been given enough credit by commentators and politicians in the West. Few of them are really curious about Chinese history and the Chinese approach to economics, politics and society. Mike Pence’s speech to the Hudson Institute last October was a sign of this, and one of the great challenges China will face in coming years is the realization in Washington and Brussels that China is pulling level with them in some domains.

Looking ahead, the great risk for China is that the ‘Dream’ runs out of momentum, economically in that growth slows, and politically in that people in China question a model that exchanges liberty for stability. The underlying risk is that not having experienced a formal recession in close to twenty years there is a great deal of inefficient capacity built up in China and that a downturn will expose this. If it does, rising unemployment will create a new political challenge for the all-powerful Xi Jinping.

In this respect, the manner in which China manages the protests in Hong Kong will provide a clue as to how the Communist Party will manage emerging political challenges. A physical, confrontational approach will open up many risks – political contagion, sanctions on the Hong Kong economy and a loss of soft power. A more drawn out approach that contests the legitimacy of the ‘two systems’ and that penalizes locals in Hong Kong by slowing the local economy may well dampen the crisis from a Chinese perspective. It must then confront the tenor of elections in Taiwan in early 2020.

Political volatility is thought to be the preserve of the West. One of the great surprises of the early 2020’s may be the way it spreads across emerging countries, with China as no exception.

Have a great week ahead,

Mike

Beyond Brexit – a plan for Northern Ireland

Light ahead for Northern Ireland?

I am trying hard not to write about Brexit, partly because it is so unpredictable and partly because so much else has been written and said about it. There are however two economics related angles that are worth mentioning. The first relates to the challenge of reviving the British economy after Brexit, and I covered this in a Times oped earlier this week (Times.html). The other is the longer socio-economic future of Northern-Ireland.

One of the frustrating and revealing aspects of Brexit is the way it has shown a lack of real interest in the North from some British politicians. For instance, in the recent past Boris Johnson has compared the border between Ireland and Northern Ireland to the boundaries of London’s congestion charge zone.

This  level of ignorance is a pity because the reality is that Northern Ireland is one of the poorest economic regions of the UK, falls well behind the level and rate of growth of Ireland the Irish Republic and continues to suffer social, political and economic rigidities. Social divisions are being mended all too slowly, local politics at Stormont is inadequate and the economy remains embarrassingly overdependent on government spending.

Brexit has shone a light on many of these issues and has illuminated the lack of appreciation many in Westminster have for Northern Ireland in particular and Irish history in general. Arguably, a film (‘Titanic’) and tv series (‘Game of Thrones’) have done more for Northern Ireland’s fortunes than its local and London based leaders.

In particular Theresa May’s Brexit strategy was fatally snared by a shoddy understanding of the complexities presented by the border between Northern Ireland and the Republic. Indeed, there is a risk for Britain that Brexit is replaying the divisions and debilitating bitterness of the Ireland’s separation from Britain in the 1921 Anglo-Irish treaty.

Yet, while there have been very few if any winners in the Brexit process so far, it does represent a valuable opportunity for London, Washington, Dublin and Brussels to recognize that Northern Ireland needs a second wind in terms of its socioeconomic development. Irish America can add an important voice of support here. Northern Ireland should not be parked as a political issue but should be cultivated economically and socially.

A provocative but potentially fruitful suggestion is that a portion of Britain’s Brexit exit ‘settlement’ to the European Union be set aside as the basis or seed capital for a Marshall Plan–type fund for Northern Ireland. This could then become a joint UK-EU financed fund with further funding from the UK, the EU and its institutions like the European Investment Bank. The fund would not substitute for spending in Northern Ireland by London but would have the long-term aims of increasing socio-cultural harmony, human development and the economic potential of Northern Ireland’s economy.

Another interesting source of funding is the growing appetite in capital market for social impact investment opportunities. This potential supply of funding is not yet met with a large, coherent supply of impact investment projects, partly because this kind of investing is not yet well understood and partly because it is difficult to create large scale projects here. Northern Ireland could be a model for doing social impact investing in a meaningful way.

The really interesting part of the proposal is that neither London, Dublin, Brussels or even Washington would be involved in planning and running such a program. This would be done by a group of small, advanced economies – the likes of Sweden, Singapore and Switzerland.

This approach would have political and economic attractions. The first is that few if any of these small, advanced countries has political ‘baggage’ with respect to Northern Ireland and would be therefore less likely to fall foul of the distrust that bedevils politics in the North (for example, the advice of New Zealand technocrats might be easier to take, and more credible than policies crafted in London or Washington). 

Secondly, and more tellingly, small advanced countries are the source of the secret sauce of economic, social and human development. They tend to dominate the league tables of socio-economic success, from ‘most globalized’ to “most innovative nation” or most “prosperous nation.” Indeed, the small advanced country model is acknowledged in Northern Ireland’s ‘Economy 2030’ plan.

What small, advanced and open economies have in common are drivers like education, strong institutions, the rule of law, and the deployment of technology—their intangible infrastructure. Northern Ireland needs better ‘intangible infrastructure’, applied in an imaginative and constructive way.

A few examples of what a small state led fund might tangibly focus on include the kind of skill-based apprentice schemes found in Austria and Switzerland, rezoning of housing from deeply politically entrenched areas using the social-impact-investing model found in Belgium, investment in cultural projects that are common to all communities (such as is done in Scandinavia and Switzerland), and the establishment of poles of excellence in certain professions, such as legal financial services.

Such a fund might draw on the expertise and governance capabilities of small states. This might well add energy and transparency to policy decisions and the employment of detailed rolling five-year plans might help speed up what is at times a sclerotic policy process.

Given the frequent and urgent manner in which parties to the Brexit process annunciate the risks to Northern Ireland in general and the Peace Process in particular, it is time they do something to set it on a positive course. It is also high time that Brexit produces at least one good news story.

From Rotten Heart to Braveheart?

Boris was wrong!

Regular readers, especially those toiling away in dusty cities will be less than amused that I have written this note in the beautiful setting of Nafplio, in south west Greece, whilst attending the excellent Eliamep/JeanMonnet30 seminar.

That the Greek stock market is up 35% this year and its bond yields trade some 33 percentage points below their levels of five years ago suggests some closure on the euro-zone crisis.

Another sign of this came in the market reaction to additional stimulus from the ECB. Effectively European asset prices did nothing, which I hope will persuade the ECB to move on to other policy aspects of the euro-zone system such as the need to properly regulate Europe’s fintech and payments sector.

Another important milestone in the ‘story for Europe’ came with the announcement of the composition of the von der Leyen Commission. In a previous Sunday note I have mentioned the method behind the creation of European Commissions found in the tale of political ‘three cushion billiards’ recounted by the late Wilfried Martens, formerly Belgian Prime Minister, in his 2009 book ‘I Struggle, I Overcome’.

The Commission has done well this time, though it was not always the case. One of the first books I read that helped to explain how Brussels worked was Bernard Connolly’s ‘The Rotten Heart of Europe’. It was a huge hit (in the UK) and hugely controversial. Indeed, a second edition came with a cover recommendation from the then editor of the Spectator Boris Johnson (‘one wanted to stand on the desk and cheer’).

The book did much to propagate Euroscepticism in British politics, and I suppose we might trace some of the roots of Brexit to it. With some irony, Brexit has however shown that the Commission can function in a forceful way. The challenge for the EC is to now step up a level and reinforce itself for a multipolar world where it will compete more acutely with China and the US, with at the same time Russia snapping at its heels.

Perhaps for this reason the new EU President referred to her Commission as a ‘geopolitical one’. It is welcome that there is a growing realization in Brussels of the implications of the emerging multipolar world, but for my liking, Europe-Brussels does not yet have a strategic mindset, and does not fully have a sense of its power and identity in the world.

There has already been some controversy over the designation of a Commissioner with responsibility for migration as one who would ‘Protect our European way of Life’. This clumsy effort at communication is likely a nod to right wing parties across Europe, the kind of people who ‘value the Church and families as opposed to bike riding vegetarians’ as one person put it to me.

What this incident should do, is spark a serious debate on what the core values of the EU are, and in ‘The Levelling’ I invoke Alexander Hamilton to do this. The more public life in the US and the UK disintegrates, and the more heavy-handed China is in Hong Kong, the more we are reminded that liberal democracy is at the core of Europe’s value system. One of the challenges is to make the benefits of this clear to people in Poland and Hungary whose leaders contest such a view of the world.

Back to the Commission, where several appointments will have macro and investment implications. Overall, the Commissioners are less wealthy than the Trump cabinet, better organized than the Johnson government and more colourful than the Xi Jinping administration.

Trade first. The appointment of Irishman Phil Hogan as trade commissioner means the EC will hold a firm negotiating line on Brexit, and that it is increasingly focused on the risk that President Trump might open up a trade war with the EU. The appointment of Sabine Weyand to the trade team reinforces this view.

Then, the re-appointment of Margaret Vestager as EU Competition Commissioner underlines the fact that a growing market trend will be regulatory risk to large US tech companies. Europe has already taxed and fined the FAANG companies and some Democrats increasingly agree with this stance. As the 2020 election approaches, tech will be increasingly under regulatory scrutiny and like it or not Europe will lead the way.

The final point worth waking here is the emphasis that the EC is putting on green investment, on governance in Eastern European countries and on socially responsible finance. This all adds up to a much greater emphasis role for ESG (Environment, Social and Governance) in investing and markets, not just in Europe but further afield.

So, the EC is moving away from ‘Rotten Heart’ but is not yet ‘Braveheart’!

Have a great week ahead,

Mike

The consequences of bad behaviour

Waiting for comeuppance

In chapter five (page 127 to be exact) of The Levelling I wrote about the apparently growing tendency for some politicians to be self-centered and incompetent, and drew a contrasting portrait of Boris Johnson MP and the late Peter Carrington. It went as follows…

‘A further contrast in political types might help illustrate this point further. In July 2018 Boris Johnson resigned as British foreign secretary. Britain no longer has an empire, but the office of foreign secretary is still respected. During his tenure, however, Johnson made a number of gaffes and was generally seen to have damaged rather than advanced Britain’s interests. Similarly, in the aftermath of the Brexit referendum, he was also seen as a natural leader of the Tory Party, but the way he has conducted himself since then has led many party colleagues to the view that, even by the standards of politicians, he is too self-serving, and he has lost support within his party.

The day after Johnson resigned as foreign secretary, the death of Lord Carrington (at the age of ninety-nine) was announced. Carrington had been British foreign secretary from 1979 to 1982. He was generally recognized as an exemplar of integrity in public life. Early in his political life, he had served in Winston Churchill’s cabinet of the early 1950s; later he was defense secretary for Edward Heath and then foreign secretary to Margaret Thatcher. To cut a long and good story (of his life) short, he resigned as foreign secretary three days after the Argentine invasion of the Falkland Islands on the grounds that the invasion happened on his watch and was therefore his fault.

As political resignations go, this one was seen to be selfless and principled and stands in contrast to the tactical maneuvering of some politicians today. Carrington, along with many contemporary central bankers (Paul Volcker, Ben Bernanke, Janet Yellen, and Mario Draghi, for instance), is a good example of sincere public service and his behavior stands in contrast to that of successors like Boris Johnson.

The distinction I wish to draw is to have policy makers who are more responsible for and focused on policy making than on their own personal advancement. Advancing oneself is, of course, prevalent across all organizations and institutions, but the difference with politics is that people’s lives are affected by bad policy making’.

At the time, I did not think Boris Johnson would become Prime Minister, though there was a good chance that this might happen. Further, given everything that has happened with Brexit so far, it was still hard to imagine that in a few weeks his government has managed to effectively destroy the Tory Party, the Union and the very large stock of goodwill that Britain has built up with neighbouring countries like Ireland.

I believe that the Tory Party will soon formally split, and that the nucleus of a new centrist party in British politics will be formed around the twenty one MP’s who were expelled from the Conservatives.

Another consequence is that the barriers to Scottish independence are falling. Most of the arguments deployed by Brexiteers for ‘taking back control’ appear logical in the case of Scottish independence. Everything the Johnson government does shears away at the moral and emotional ties between London and Scotland. Moreover, the departure of Ruth Davidson as head of the Scottish tory Party will hand back a number of seats to the SNP. The challenge for Nicola Sturgeon now is to convince Scots that the SNP can execute new policy ideas that will make Scotland more stable economically, and richer in terms of human development.

Then, both the Irish government and the EC will feel that their opposite numbers in London have no credibility and no sincerity. Whereas they were often puzzled by Theresa May, Boris Johnson has done nothing to encourage Brussels to trust him. That is a pity because once Britain leaves the EU, the truly complex business of negotiating its future relationship with the EU will only begin. This is apparently lost on the Johnson government.

To return to the distinction I drew between Johnson and Carrington, there is an emerging theme in public life that the consequences of bad behavior are in many cases low. There are many instances, Jeffrey Epstein is the latest, where individuals have engaged in enabled, persistent abuse. Politics is sadly becoming similar. The world stage is increasingly replete with examples, with little distinction between leaders in emerging or developed countries.

In time, very bad, divisive behavior in politics hits its limits and is sanctioned. What is disappointing is that those limits are being stretched to breaking point.  At times, markets can sanction bad policy by politicians, but bad personal behavior is seemingly harder to check. Infuriatingly, social media seems to amplify and reward bad behavior in politics.

A more profound policy issue is that the lack of real economic growth, and the poor distribution of its benefits (in countries like the US) means that voters will look beyond reckless policy in search of economic rewards. In the US specifically, few on the right are prepared to stand up to the President. They might do well to look at the example set by the likes of Ken Clarke, Jo Johnson and Rory Stewart last week. Boris Johnson himself might do well to look at the example set by Peter Carrington.

Have a great week ahead,

Mike

Faultlines in a fracturing world

Cracks appear in the world order Source: Esquire

The front cover of ‘The Levelling’ – clearly the best part – shows a deflated globe. Another way of getting this message across might have been a crystal globe, with cracks appearing.

This came to mind last week as I was summing up some of the important geopolitical and economic catalysts for my first column as a contributor to Forbes, where the aim is that I write on events outside the USA for a largely USA centric audience (https://www.forbes.com/sites/mikeosullivan/2019/08/29/faultlines-in-a-fracturing-world/#3f9c31415890))

My sense, which is now reinforced daily by events such as the trade war, is that there is a fracturing of the old world order that is exposing a range of faultlines. The established world is cracking, the question is whether it will shatter, or whether it can be repaired.

There are at least two varieties of faultline. The first set is where we have the intersection of a disruptive macro development with an existing or incumbent industrial structure – think of the impact of negative interest rates on the European banking system, or the effect of the trade war on corporate supply chains or increasingly, the collision of ethics and technology (for instance opioid drugs or big data).

The second element in the fracturing of the world order relates to geographic areas and/or nation states. A number of them are increasingly making the news and are beginning to cause market ripples.  Strikingly, in each case the fracturing is picking up speed at an alarming rate such that we now go into September beset by three full crises.  

The one that preoccupies me most is the situation in Hong Kong, partly because I love the city and mostly because the ongoing demonstrations there are a microcosm of grander political battles to come – between a state of the world where people sacrifice their liberty for order and economic growth or one that we could call an open society/open economy model.

Should the situation deteriorate further, the onus will be on the US, EU and especially the UK to speak out more volubly, to China’s chagrin. Police violence and the recent arrest of some of the prominent demonstrators is an escalation in this conflict – I am not sure whether this is simply an error or a provocation to the protestors.

I have underlined in past notes that the Hong Kong protests are primarily an issue of liberty and identity, but market and investors are now also been drawn towards it with some focusing on the Hong Kong dollar peg as a source of volatility. I am not so sure – only a major political event such as a Chinese takeover of Hong Kong could push the peg to the top of its range. A more obvious Hong Kong contagion play might be the Chinese currency itself, with a long yen trade as an additional way of expressing risk aversion in Asia.

The situation in Hong Kong would be more alarming if we did not have Brexit as a benchmark, which was the first big rupture in the ‘end of globalization’ thesis. In a sense, nothing has happened with Brexit in that the UK has not yet left the EU, but at the same time the road to Brexit has taken a mind-boggling series of twists and turns.

A difficult, messy ‘hard-Brexit’ looks likely in late October, largely because Boris Johnson has caused so many people to lose faith in him and has whittled away any goodwill he had with Brussels. The step to prorogue Parliament took Brexit into a new realm, a very disturbing one for those who hold the view that what makes Britain are its laws, democracy and institutions. The move will possibly make a hard Brexit more likely, and certainly means that the post Brexit political climate will take on the bitterness of a civil war.

Finally, I am keeping an eye on the two biggest economies in Latin America – Argentina and Brazil. Both represent last chance experiments for populist politics, with the possible electoral overthrow of Mauricio Macri by Alberto Fernandez in Argentina and the increasingly troubled tenure of Jair Bolsonaro.

I recently wrote that the steep fall in the Argentine peso and in its government debt means that it is one of the few countries where sovereign risk is now beginning to be correctly priced, though the implications of Argentina’s attempt at yet another debt restructuring could lead to further downside for the currency and stock market. This would spill over to Brazil, whose stock market is vulnerable to an increasing lack of clarity in policy making and an increasingly contentious foreign policy. In each case, the strong dollar is an unwelcome financial headwind.

A potential formal default by Argentina may well also further damage the credibility of the IMF and by extension Christine Lagarde. The only good news is that Argentina’s woes will mean that austerity is no longer the knee-jerk response of bodies like the IMF to financial crises.

September promises to be lively.

With best wishes,

Mike

Gone fishing – Jackson hole in 2039

Trout, an important fish in the history of central banking

Two years ago I wrote an oped for the Financial Times (https://www.ft.com/content/9089eaf8-83fe-11e7-a4ce-15b2513cb3ff ) the byline of which ran ‘Jackson Hole offers a chance for central banks to hand over baton – It is time for central banks to let governments take on more of the burden of economic policy’. That I could reprint the same article today says much less about my foresight and much more about the stopped clock of international economics and finance.

Central banks should long ago have stepped back from generously providing stimulus to economies and markets, particularly as the economic impact of quantitative easing (QE) is diminishing, if not negative in terms of the effect of negative interest rates in banking systems.

Moreover, clever fiscal policy should be been deployed some time ago, especially in Europe where growth is stubbornly low. More broadly, the reality is that many governments do not have the fiscal capacity to stimulate their economies and more importantly to cushion the effects of a coming recession. President Trump’s economy is a case is point, with a historically high budget deficit (5%) and near record level of debt (to GDP).

Many of these issues will have been discussed at the Kansas Federal Reserve ‘offsite’ at Jackson Hole, Wyoming. The event has become one of the more important platforms for central bankers, due in little part to its proximity to decent fishing. Legend has it that up to the early 1980’s the Kansas Fed struggled to attract participants to its annual conference but came up with the idea of hosting it in Jackson Hole, because the prospect of excellent trout fishing might lure then Fed Chairman Paul Volcker (a keen fisherman) to the conference. The strategy worked and Jackson Hole gathering is now internationally famous and attracts many professional central bankers, whose pronouncements are closely followed by markets. Never before has trout played such an important role in central banking.

The title of this year’s symposium was ‘Challenges for Monetary Policy’. Whether on purpose or not, this title echoes with the Jackson Hole symposium of twenty years earlier. In 1999, the likes of Mervyn King, Alan Greenspan and late economists and central bankers like Wim Duisenberg, Rudiger Dornbusch and Martin Feldstein gathered to discuss ‘New Challenges for Central Banking’.

Their debates, which occurred in the wake of the Emerging Market and LTCM crises, just tell us much about the persistence of financial market phenomena such as asset price bubbles and the ways in which the central banking community has a tendency to fight ‘yesterday’s monetary wars’ rather than those of the future. A couple of things struck me.

One was the focus on price stability – in particular comments from Wim Duisenberg, then the first head of the European Central Bank, whose comments reflected the orthodoxy of central banks like the Bundesbank that price stability was the holy grail of central banking, something that itself had roots in prior decades of inflation.

Inflation, in consumer prices at least, is now well and truly dead, killed off not so much by central bankers but by the residual effects of the global and eurozone financial crises on household balance sheets. In this light and with the euro-zone in mind, it is interesting that (apart from Feldstein) there was very little mention in 1999 of the frailties of the euro-zone system.

The second interesting factor in the 1999 meeting was a discussion on asset prices and monetary policy. There was a firm consensus then that central banks should not tackle asset price bubbles head on. The rest as the say is history – the 2001 dot.com bubble and then the housing and derivative bubbles of 2007 that led to the financial crisis. Today, there is not enough discussion amongst central bankers about the effect of monetary policy on wealth inequality or on the bubble in fixed income markets. If and when the trillions of bonds in and around negative yield territory sell-off, this will produce a crisis in central banking.

Indeed, if we move forward twenty years and think of what the 2039 Jackson Hole symposium will discuss, I can hazard at least three topics. The first will be an evaluation of central banking credibility following the ‘Great QE Bubble of 2021’. The second might be ‘Does Facial Recognition Improve the Efficiency of Central Bank Digital Currencies’ and a third might be ‘The Effects on the Emirate Economies of Euro-zone Membership’. Much to think about for the future.

Have a great week ahead,

Mike

Death of the bond market

Now time for the death of bonds?

This week a very wise friend alerted me to the fact that exactly forty years ago, BusinessWeek magazine decorated their frontpage with the proclamation of  ‘The Death of Equities’. As with many bold magazine covers, they got it horribly wrong. At the time the S&P 500 index stood at 107, and it has recently touched over 3,000.  

Part of the reason that equities have done well is that inflation has been brought under control (largely by Paul Volker and to a degree by Alan Greenspan) and as a result interest rates have fallen structurally. Indeed, if one were to craft a magazine cover today, it might carry the title ‘Death of the Bond Market’ such has been the rally in bonds (half of bonds internationally have a yield below 2% and 20% are in negative yield territory. Perhaps the ‘Death of the Central Bank’ might be an even more provocative headline.

The historically odd phenomenon of negative yields signals lower trend economic growth, the end of globalization, the fracturing of the world order and the failure of policy makers to address these issues. The bottomless ‘central banking toolbox’ has as they say become the only game in town, but it increasingly produces market distortions rather than economic solutions.

With many other writers scribbling away on negative rates, the development that struck me last week came in the tiny sliver of the bond market where yields trade above 10%, and specifically with Argentina, which a year before the BusinessWeek headline, won the World Cup. Argentina has been a constant source of volatility in markets – it has defaulted on its debt eight times since its independence, seen many restructurings and economic crises.

Last week, a primary election vote suggested that Mauricio Macri is unlikely to gain re-election and this prompted an over 30% collapse in the peso (to 55 to the dollar compared to 18 when Macri came to power), and a similar downshift in its stock (Argentina was admitted to the MSCI Emerging Market index in May) and bond markets. With broader bond markets now beginning to price in a recession, there are several lessons from Argentina.

The first relates to country strength – which I define as the ability of a country to withstand economic and financial shocks. The robustness of its economy and the quality of its institutions are two of the factors that make up country strength. That markets can move so dramatically on the likelihood that Macri may not win a second term, shows that Argentina is low on ‘country strength’.

Conversely, as David Skilling of Landfall Strategy shows in his excellent, annual ‘State of Small Advanced Economies’ Report, the likes of Singapore, Norway and Switzerland rank amongst the highest in the world on factors like productivity and human development that help to generate ‘country strength’ or ‘resilience’ (https://twitter.com/dskilling/status/1162232440468824069). As the trade war deepens, this factor or quality will become increasingly prized by markets.

In emerging markets, this will be doubly the case, not least as globalization gives way to a multipolar world. Here, the example of  Argentina in the 1920/30’s is worth studying. At the time, the world was coming to the end of the first wave of globalization, and Argentina was an economic and financial powerhouse. However its economy was heavily dependent on agriculture and as a result was not resilient enough to deal with the collapse of globalization. The rest as they say, is history.

Argentina and the predicament of Mr Macri also hold lessons for international policy makers. Should Macri be replaced with the Alberto Fernandez government that markets fear, this will further damage the reputation of the IMF, and its austerity first policy recipe-book. Macri had pursued financial reforms but the effect of austerity has been politically costly. Much the same is true across the euro-zone. In future, if there are to remain relevant, bodies like the IMF will need to work around the political consequences of reform programs, and the time inconsistency implications of them for politicians.

Reform minded governments usually do not last to see the fruits of their labour, and as such reform programs may well need to be tilted away from fiscal consolidation and more towards supply side and institutional measures that will improve a country’s ‘strength’, and that will give serious political reformers a chance of staying in power to enact their policies. To this end, it may make more sense for bodies like the OECD to be more involved in economic rescues than the IMF.

For the time being, Argentina’s debt is an outlier in that it is perhaps one of the few fixed income assets that correctly reflects a country’s fundamentals, rather than the mirage of ‘QE’ (quantitative easing) driven pricing. In this way it is ‘normal’ and the rest of the bond world is increasingly absurd.

Have a great week ahead,

Mike

Is Trump Hoover?

Herbert Hoover in better times

Over a week ago I penned an article for Dow Jones/Marketwatch where I predicted (note that I only use this verb after the event) that the recent rate cut by the Federal Reserve would mark the top for equities. The subsequent volatility, and of course last week’s missive on the yuan, prove me to be a financial market genius.

More seriously, recent volatility is a reminder of the fragility of investor behavior and of the risks lurking in the global economy. On a longer scale, as we approach September, they are a reminder that while the global financial crisis of 2008 did not quite end in an economic depression, neither has it produced a true economic renaissance. Many of the factors that caused the crisis in the first place—indebtedness, corporate risk taking and poor governance—have simply been in abeyance, hibernating, and are now again emerging into the daylight.

One consequence of these persistence economic fault lines is that we are in a political depression. In this light, some respected commentators—notably, Madeleine Albright in her book Fascism: A Warning—draw parallels between political figures today and those of the 1920s and ’30s. Recent events in the US, and comments by the President reinforce the parallel.

In ‘The Levelling’ my intention is to avoid the gloomier comparisons with the 1920’s/30’s, but the deepening trade dispute between the US and China makes them inevitable. One reason that President Trump has been eager to push the Federal Reserve to cut interest rates is that he ‘doesn’t want to be the next Hoover’.

Other commentators have already been making this comparison with Herbert Hoover (President from 1929 to 1933). Paul Krugman recently wrote that the level of tariffs applied by the Trump administration is now close to that of the Great Depression.

Hoover was different to Trump in that he distinguished himself in various ways, notably in his humanitarian work in Belgium with the US Food and Drug Administration, and in Central Europe in the aftermath of the First World War.

In other ways, he has several things in common with President Trump: German/British parentage, a business background, and a mastery of new communications channels, in Hoover’s case the use of radio (rather than Twitter) to reach voters and the introduction of the press conference as a regular political event.

Furthermore, the trade dispute between the United States and China has excited commentators who fear that Trump may repeat the mistakes of the Hoover government. Even the Wall Street Journal editorial team warned last year that the Trump trade team is like Senator Reed Smoot and Representative Willis Hawley, promotors of the disastrous 1930 Smoot-Hawley Tariff Act. The same newspaper now talks of a ‘Navarro Recession’, in honour of Trump’s trade adviser Peter Navarro.

 The Act aided and abetted the onset of the Great Depression with the introduction of tariffs of up to 60 percent on twenty thousand types of goods imported into the United States. The net effect of the Act was to squash any hope of an economic recovery in the aftermath of the Great Depression and to cut world trade by 33 percent.

In addition, readers might tremble to know that Hoover took office with US equity valuations at very high levels. Robert Shiller’s excellent database highlights that the US market’s price to earnings ratio was at 32 in January 1929 (the highest it reached was 44 in December 1999) and that it reads 29.5 today, which is 75 percent higher than the historical average of 16 and thus puts the market in expensive territory from a valuation standpoint. Eight months into Hoover’s term the Wall Street Crash occurred, and the United States lurched first into recession and then into the Great Depression.

Whenever the market wobbles as it did last week, some investors revisit the ‘Great Depression’ hypothesis, and many others point to a coming recession. For my part I am sticking to my cautious line for a number of reasons.

First the trade war is a reminder of the many policy risks in the world (widespread negative yields are another pointer), and of the fact that as growth slows, countries will squabble more over the crumbling pie of globalization.

Second, moves in other asset classes than equities – government bonds, even corporate and high yield bonds and particularly commodities are bearish

Third, the world is becoming more fractured. South Korea and Japan are locked in a trade dispute, and there is a growing risk of some form of confrontation between India and Pakistan. Do not of course forget events in Hong Kong, and the untethering of the yuan.

With lots to watch, have a great week ahead,

Mike