Paul Volcker

Voclker, the anti-populist

This important week has been marked by the passing of Paul Volcker. Many commentators have already paid tribute to a remarkable man. Martin Wolf in the Financial Times referred to him as the ‘greatest man I have known’.

I have never met Volcker (though am privileged to share an excellent editor with him in John Mahaney at PublicAffairs who has edited ‘Keeping at it’) but I wanted to write about him because his legacy touches on the themes in ‘The Levelling’, and more importantly on the state of the world today.

In that context, Volcker stands for many of the things that are missing in our international political economy – a willingness to take unpopular though telling policy actions, the independence of central banks from markets and politicians, and the integrity of those in public life.

His accomplishments as a central banker, his role in helping survivors of the Holocaust recover their savings from the Swiss banks and his views on banking (i.e. the Volcker Rule) underline these qualities.

When he was appointed as Chair of the Federal Reserve, the central bank was nothing as powerful as it is today. Arthur Burns, the Chair from 1970 to 1978, was widely seen as being close to President Nixon, and had later been undermined by the Nixon White House. William Miller who followed Burns, had a short and inglorious career as a central banker (March 1978 to August 1979) and was promoted ‘out of the way’ to become Treasury Secretary. His legacy, a sharply weaker dollar and inflation barreling towards 15%, is beyond the imagination of many people today. Bluntly, high inflation became the policy problem of the day.

Volcker took the reins at the Fed with a clear view as to what needed to be done (‘This is going to be tough, but we are going to stick with it and the inflation rate is going to come down’). To the credit of President Carter who appointed Volcker, Carter also understood the consequences of what Volcker would do. During Volcker’s ‘job interview’ with Carter, Volcker thrice stressed the magnitude of the policy task at hand, to which Carter acquiesced.

By the mid 1980’s Volcker’s medicine was taking effect. Inflation was falling, but the personal costs of his role were also growing. Homebuilders regularly sent him blocks of wood to remind him of the burden that high rates were having on the housing market, and threats to his safety meant that Volcker needed a bodyguard.

Political resistance was also growing. In his book, Volcker mentions a meeting with President Reagan and his chief of staff, James Baker, where Baker reportedly insisted that Volcker not raise interest rates at a forthcoming Fed rate setting committee. Volcker’s response was to get up and leave the meeting.

Thus he cemented the independence of the Fed (Reagan later appointed several White House ‘friendly’ board members to the Fed to stymie Volcker), drove down inflation and in doing so triggered perhaps the most important macro trend of the past thirty years in the shape of the permanent, lower resetting of interest rates and inflation.

This enabled the economic boom in Reagan’s America and provided the structural basis for globalization. Globalization could not have happened and survived if the US economy, and by extension the rest of the world, had had to endure bouts of high inflation and sharp rises in interest rates. Many people today will know little about Volcker, but in a fundamental way, his actions have impacted their lives.

In the sense of the way in which we read our world today, Volcker could be described as an ‘anti-populist’. He was a humble technocrat, or expert, who confronted very tough decisions, with unpopular side-effects. There are at least two reasons as to why he should be studied.

The first is that the world is beset by the accumulation of near existential risks – indebtedness is the highest it has been since the second world war and the Napoleonic Wars before that and, the climate is warming at a rate never seen in the past two hundred years and many cities suffer paralyzing pollution. These and other risks badly need a Volcker type character to resolve them, or else they will be patched up in a crisis. Policy makers need courage, rather than new frameworks.

This is doubly true in a world where the ECB and the Fed are experimenting with new ways of encroaching into the political economy and by extension, of distorting markets. Quantitative easing and negative interest rates have not created organic economic growth. Instead they drive asset bubbles, build wealth inequality and give reckless politicians the cover to engage in poor policy (i.e. Trump’s trade war). Developed world monetary policy risks fatally compromising itself. Volcker would not approve, neither should we.

Deal done – Trump saves euro!

Wrong way!

In a missive I wrote earlier this year I puzzled whether Trump would fall victim to the same policy mistakes as Herbert Hoover (‘Is Trump Hoover?’,https://thelevelling.blog/2019/08/11/is-trump-hoover/). This does increasingly look to be the case, as the economy is slowed down by the debilitating consequences of trump’s trade war with China.

However, a reading of the Art of the Deal (consider quotes like ‘I’m the first to admit that I am very competitive and that I’ll do nearly anything within legal bounds to win. Sometimes, part of making a deal is denigrating your competition’) hint at some method behind this week’s trade related threats to China, the EU and France, not to mention the ongoing undermining of NATO.

It grants far too much credit to Donald Trump to describe him as the architect of a new world order, rather he is the bull in a china shop of increasingly brittle crockery. His role, in the context of the fracturing of the old, globalized word order is to help highlight what elements in that world order are fragile and which ones are resilient. The checks and balances in the US political system, and the wisdom embedded in them through the Federalist Papers for instance, are so far proving resilient.

Arriving in Europe this week, Trump clearly had two targets in mind – the EU and NATO, both of which lie on the deepening faultline of the consequences of America’s diplomatic estrangement from Europe. Trump has rarely had anything better to offer either institution save scorn and division. In my view this is a pity, and simply wrong.

NATO and the EU are fine examples of how collective action usually requires a strong common cause to enforce it, and that absent the magnetism of that common cause (broadly speaking the Cold War), cohesion between members begins to ebb. In addition, both institutions are finding that they have a common design flaw – namely the lack of an exit. Neither NATO nor the EU (not to mention the euro-zone) have processes where a recalcitrant member can be kicked out. Brexit shows us that even those who volunteer to leave, find it difficult.

To make an analogy, no public building can be used without a fire escape or carefully marked ‘exit’ in place, and it should be the same for multi-lateral institutions in a changing, multipolar world. This multipolar world is one where nations will increasingly have to take sides. In this context, Turkey’s membership of NATO will become increasingly problematic, and the position of EU members like Hungary, and prospective candidates like Serbia also looks strained. My prediction is that both NATO and the EU will have to change their uni-directional membership rules to include a ‘black-balling’ process.

That NATO rests on the emerging faultline of US-EU relations gives us a clue as to its future. The logical contradiction is that the White House could soon declare a trade war on Europe, at the same time as partnering with the EU to fight ‘real’ wars. To paraphrase Justin Trudeau, it is enough to make ‘jaws drop’, though it is not as peculiar as it seems. For instance, in October, as the final wrangling over the UK’s Brexit deal was taking place, French commandos joined their British counterparts in a joint operation called ‘Griffin Strike’, part of a larger cooperative exercise between Europe’s two military powers.

One way for the EU to contribute to its own security in the context of a multipolar world where the US is a less unambiguous ally, apart from making sure its military kit works (only one sixth of German helicopters and fighter planes are operational), is to develop its power as an economic and financial player.

Theoretically this approach fits into the ‘total war’ doctrine developed by Russian General Valery Gerasimov, where financial networks are just as useful strategic tools as fleets of submarines. The effect of American sanctions on Iran is one recent, powerful example of this.

To that end, the new Commission has a long task list, but it should focus on the following. First, bolster the international credibility of the euro by enforcing the Maastricht guidelines of debt levels to the point that countries with debt above the Maastricht threshold should have a portion of their debt deemed ineligible for ECB purchases and for collateral exchange.

Second, continue to clean up the follow of ‘dirty’ money across Europe’s banks and fintech players. The relatively new EBA (European Banking Authority) has failed to do this.  Third, think how infrastructure development in countries like Poland and Greece can be better supported by the EU and by EU based private investors, instead of those countries swaying towards Chinese state led investment.

If these and are other measures are enacted, Donald Trump may prove the catalyst for a stronger euro financial system.

Have a great week ahead,

Mike

Tall Tales

What’s the story?

When Robert Shiller won the Nobel Prize for Economics in 2013  (shared with Lars Peter Hansen and the great Eugene Fama), I recall being particularly pleased for him. He is, rightly I suspect, a skeptic of the antics of financial markets, having twice called the top in market bubbles (dot.com and housing crisis). He coined the phrase “irrational exuberance,” which was used to powerful effect by Alan Greenspan.

Then, famously during the dot.com crisis, he was derided by many in the financial community and on CNBC for his pronouncements that markets would collapse. He handled himself with grace and had the last laugh. In addition, he is an economist with a practical interest in markets and asset prices, and many of his housing and stock market metrics are now widely used.

Well before academics shared data publicly, Shiller made his long-term market valuation series available on the internet. This open source approach is perhaps one of the reasons why his long-term data is now widely referred to. The key metric here is what is called the Shiller P/E (price to earnings ratio) or, as he himself puts it, the CAPE, the cyclically adjusted price to earnings ratio. What this essentially does is normalize earnings across the economic cycle.

The CAPE is now at a level only previously reached in 1929 and 1999/2000. We know what happened next in both of those cases. This doesn’t seem to worry investors, largely because the market narrative is built around the notion that ‘a trade deal will be done any day now’ and that the Federal Reserve will continue to dose markets with liquidity.

Interestingly, the idea of the macro ‘narrative’ is the focus of Shiller’s most recent work (he has a book out entitled ‘Narrative Economics’ as well as several papers on the topic). Essentially, he investigates the ways in which we (households, investors, economists) tell stories about the behavior of economic events and market trends. I would argue that ‘The Levelling’ is a narrative on what is happening to the old world order and on how it would evolve.

Shiller’s ‘narrative’ based strand of research is not new. Pop economists have for a long time made sense of the world by coining understandable terms like ‘white van man’, and for an even longer time, stockbrokers have told stories around stocks and markets, and their clients have readily swallowed these stories.

I tend to classify the spectrum of the finance industry as having two ends – storytelling and quant. Story tellers are not good quants, and quants are not good storytellers. What is interesting now is that quant, be it through the provision of new and better datasets, is providing the narrative ammunition for storytellers to tell more elaborate, and possibly convincing, macroeconomic stories.

Storytelling is also a neat way of bunching together the various trends in markets. For instance, there is a notable divergence between what we might call drugged assets (assets that are under the spell of central bank liquidity) such as the Dax, quality corporate bonds, euro-zone debt and the S&P 500 index, and those like emerging market currencies, some commodities and crypto currencies (see last week’s missive) that do not have the outright benefit of central bank asset purchases, and that as a result tell a cleaner picture about the relatively weak global economy.

As we head into December expect many to continue the narrative that central bank liquidity will suppress volatility, and I suspect that in general this narrative will continue to hold into 2020.

One narrative that may pick up pace, is the idea I explored a few weeks ago of ‘Demonstration Contagion’ (link). Under this narrative, the panoply of protests around the world are both distinct and have common perceived causes such as inequality and climate damage. In particular, events in Hong Kong cut across many of these issues, and there is a great deal at stake economically and politically.

The new developments are that President Trump’s (by the way Shiller describes him as a ‘master of narratives’…Shiller is a master of irony) signing of the Hong Kong Human Rights and Democracy Act and the overwhelmingly pro-democracy tenor of last week’s council elections in Hong Kong, provide two threads to tie events in Hong Kong to the trade dispute between the US and China, and to January’s Presidential elections in Taiwan.

As such, protestors in Hong Kong have every incentive to continue to protest, and the Chinese authorities cannot but feel more uncomfortable. As crowds in Hong Kong this weekend hold aloft the image recently tweeted by Donald Trump of his head superimposed on the body of ‘Rocky’, the Demonstration Contagion narrative is only just warming up.

Have a great week ahead,

Mike

From Bitcoin to no coin

Falling down

Things are stirring in the cryptocurrency world. There is a burgeoning debate about central bank issued digital currencies, and in the past month bitcoin has fallen by over twenty percent.

In its short life as a trading asset, bitcoin has appeared to move in sync with equities, so this recent move may spark some concern. A more intriguing, related question is whether bitcoin is an indicator of risk appetite or a beneficiary of risk aversion. Indeed, within the less ‘independent’ crypto currency community there is a view abroad that bitcoin and crypto currencies are a ‘safe haven’ in the same way people might for instance, regard gold.

My own sense is that crypto currencies in general and bitcoin specifically are not safe havens. They have failed the purpose they were intended to fulfill in that they are not actively used as a means of exchange. Few retailers accept them, fewer consumers actively use them and transaction costs are still very high.

The technology associated with cryptocurrencies is also complex enough to dissuade most households from using them. For many people the process of setting up a crypto wallet, and mentally translating crypto prices into everyday currencies is too demanding to bother with. This ‘ease of use’ is a cognitive barrier to entry and something that will take time for many to overcome, even Millennials.

In addition, the infrastructure around cryptocurrencies is fragile in at least two respects. Parts of that system, such as exchanges are prone to hacking and ransoming, and can also be shut down at the whim of governments.

From the point of view of cryptocurrencies as assets, very basic data analysis suggests that optically bitcoin has a low correlation with safe havens like gold. This does not mean that bitcoin is a good diversifier or a safe haven. It has been highly volatile over the past two years and is subject to trading and liquidity risks not normally associated with safe havens.

A further clue as to the true nature of cryptocurrencies as investable assets comes from the community of people who hold and trade them. The micro-structure (or plumbing) of markets, as well as the anthropology and sociology of those who populate them (which will have to be the subject of a future missive) is crucial to the way they behave and subsequently to their risk characteristics.

In this light the fact that the biggest holder of bitcoins is apparently the FBI says a lot. A good deal of trading in cryptocurrencies takes place in Asia, other emerging markets like Russia and in hubs like Zug.

Though admittedly not scientific, nor thorough, I suspect that many bitcoin traders also trade equity futures and currencies and use the same equity trading rules (technical) to buy and sell bitcoin (cryptos now have their own rating system, FCAS). If this generalization holds, it suggests that risk budgeting may drive a positive correlation between cryptocurrencies and equities, especially at market highs and lows.

Another observation is that for its size (the top ten cryptocurrencies barely add up to the market cap of Citigroup) the crypto market attracts an inordinately large amount of attention, which may draw money in at high points. To my mind this points to bitcoin having a pro-cyclical bias in terms of its riskiness as a trading asset.

On a structural basis the fall in bitcoin may also signal trouble in the cryptocurrency world, which effectively exists to create means of exchange beyond the normal frameworks of governments and central banks. Note that bitcoin rallied to its year high in the immediate aftermath of Facebook’s announcement of the Libra project in mid June.

The current disarray surrounding Facebook’s Libra project is a sign of the operating and regulatory complexities facing cryptocurrencies. More powerful still is the incentive that central banks and fiscal authorities around the world have for the bitcoin not to succeed. Witness as an example the vigour with which the Chinese – who tightly control money flows – have clamped down on cryptocurrency exchanges.

The next steps in the crypto or digital currency (they are almost the same in that crypto currencies are digital currencies that use cryptography) industry for central banks to issue their own coins, and for the digital payments industry. More thorough regulation, cleaner cross-border payment processes and more reliable identification mechanisms will be part of the workload of central banks and governments.

It all suggests that instead of being a safe haven, bitcoin may become extinct.

Have a great week ahead

Mike

Europe’s next crisis

EU a beacon for the rest of the world

The decision of the German finance minister Olaf Scholz to acquiesce to a discussion on the creation of a euro-zone common deposit insurance scheme is welcome in the light of the half-baked nature of the euro-zone financial system. However, like the proverbial drunk searching for his keys under the streetlamp, it is also a case of tardy backwards looking, policy making.

For example, the facts that the market capitalization of Deutsche Bank trades at only one quarter of its book value and that the business model of Wirecard, Germany’s fintech leader, has been surgically dissected by the FT, suggest that reform of the domestic banking system is a more urgent and yet incomplete task for Germany (Mr Scholz may hope that one day Italian savers will bail out German banks).

While the ongoing focus on remedies to a future banking crisis is a reminder of Europe’s fragilities, the most damaging and alarming crises tend to strike in areas that policy makers have not yet tended to.

In that light, if Europe is going to have another crisis, it is much less likely to be economic in nature, such has been the develeraging of European economies and corporates in recent years, and such has been the focus on building new economic architecture in the euro-zone.

Rather as the new Commission takes office, their focus should be to look forward and grapple with the emerging debate in European values and identity, of which there are at least three strands.

The first of these relates to Europe’s place in the world. As globalization ebbs, and gives away to a multipolar world made up of at least three regions – US, China and Europe who do things increasingly distinctly, the organizing ethic of the EC must be to think of Europe as part of a system of great power rivalries as opposed to a cog in an integrated world. The weakening of the diplomatic ties and communications from Washington to Europe is just one sign of this.  The notion of a more singular EU points towards a deepening of efforts towards common European defence and security capabilities, a trade strategy that is prepared for ‘the worst’, and a greater effort to bolster Europe’s financial strength.

The second strand is that as the EU defines itself more clearly relative to the US, China and to a lesser extent Russia, individual member states will increasingly feel obliged or forced to take sides. Eastern European and Balkan countries, some of who enjoy investment flows from China and political support from Moscow will be the centre of attention here. Though there are few formal means of ‘bringing them onside’ there may soon be calls to curb EU aid to member states who are too closely aligned with China and Russia, or to change voting procedures to ensure that the likes of Hungary cannot sway or bloc EU wide votes.

Then, identity and the idea of European values crisis crosses country politics and has been brought to prominence with the clunky job description of ‘protecting our European way of life’ for Margaritis Schinas.

The recent rise of Vox in Spain is another example of the emergence of far-right wing political parties across Europe, and it is a possibility that we see a ‘Heimat’ coalition of such groups across the EU. Here, the EC can do several things, such as better defining what European values are in a practical sense that tallies with the everyday lives of Europeans and using social media to capture the values that resonate Europeans. Specifically, immigration is a policy area where the EC needs to have a much clearer and better organized approach, especially so in the case of refugees.

One additional factor worth highlighting, is that the generalized picture of the many protests around the world, from India, to Honduras to Lebanon, is that people want an end to inequality, corruption damage to the environment, and arguably, better democracy. The EU can take some comfort from the fact that, as a bloc, it is a leader in the field of liberal democracy, climate change and equality.

The final task for the new Commission is to dispel the sense that as Jean Monnet is reputed to have said, ‘Europe needs a crisis to move forward’. Brexit has shown how forcefully the EU can act when united and organized. Political chaos in Westminster and Washington makes Brussels look like a bastion of good sense.

Europe’s financial crisis has many lessons – the necessity to tackle emerging risks early and if anything to over rather than underreact, the need to coordinate well across countries, Commissioners and specialist areas, and the need to better communicate with Europeans as to what is being down in their name. The new Commission should internalize these lessons and move to pre-empt the ‘next’ crisis.

Have a great week ahead,

Mike

Demonstration contagion

Is this the beginning or end ?

In last week’s missive (link), I discussed the role of rising food prices as a trigger for public protest and I suspect, as a cause of future geopolitical strife. It is not a very happy topic but one that deserves some further analysis given that in recent weeks there has been a remarkable outbreak of protests across a range of countries – from riots in Honduras, to ongoing tension in Hong Kong to climate related demonstrations in India.

Were I one of the many apocalyptic writers who seize upon every misfortune as confirmation of their worldview I would tell you that this is the start of ‘The Levelling’, and that the ‘end’ will follow shortly.

Though I will spare my readers such a gloomy outlook, there is nonetheless a ‘Levelling’ like narrative that unites the motivation for the many international protests in the sense that most of them are provoked by factors that are associated with globalization (though in reality not usually caused by it).

For example, climate change has spurred Extinction Rebellion movements in Europe and environmental protesters in India. Factors that are associated with a lack of what I call ‘country strength’, such as corruption and weak institutions have been amongst the triggers for protests in Lebanon and Iraq, whilst the cost of living and rising fuel costs have brought people out onto the streets in Chile, Egypt, Ecuador and France. Inequality is also a driver, especially so in Chile, Mexico and Turkey.

Together these protests (by the way the number of Google searches on the world ‘protest’ is at a five year high) point to a world where there is limited patience for policy negligence and it negative socio-economic effects. I’ve had a look across the IMF and World Bank databases to find countries that are exposed to corruption, indebtedness, inequality and climate change. Many ‘candidates’ if I can put it like that are in Africa. One country worth watching – where inequality and indebtedness are high (as high as Jamaica), and where climate change is having a growing impact, is the US.  It still has strong institutions but consider what might happen in the context of a deep recession (with no fiscal buffer).

While there is no sense that the various protest movements are in anyway coordinated, they may still be contagious within and across countries.

Within countries, social media makes protests easier to organize at short notice, easier to spread (dis)information and easier to bring to the attention of the wider public. It was no surprise that in the aftermath of the Arab Spring, protestors faced massive social media and cyber counterattacks from the Egyptian and Syrian authorities.

Protests are contagious across countries to the extent that social media can heighten sensitivity to issues and spread the ‘methodology’ of either violent or peaceful protest. For example, one image that crops up in protests around the world is the clenched fist of the Serbian peaceful protest group Otpor. There is also increasing contagion in financial markets in the sense that in emerging markets at least investors are reacting negatively to signs of political strife.

The troubling thought for the outlook is that the economic stresses underlying these protests will not go away anytime soon – inequality takes time to tackle, most governments are fiscally constrained, and many have high debt levels (i.e. Lebanon). To make matters worse, climate change points towards a more radically stressed environment.

However, the positive reading from all of this, at a time when it should be said that the quality of democracy and the rule of law internationally are deteriorating (according to the latest Freedom House ‘Freedom in the World’ report and the Rule of Law indicators in the World Justice Project dataset) is that people want less corruption, more equal societies and better balanced growth.

In that context, what is to be done? There are specific actions that can help, such as the relocation of the World Bank to Africa to act as an anchor against corruption and to spread best practice in institution building.

More broadly, I see a lot of space opening up for new political parties and movements, some that are interlinked across countries and others that are connected by their political methodology (i.e. use of social media). Then, eventually I see the such protests leading to efforts to remake social and political contracts along the lines of the Levellers’ Agreement of the People’, at least in democratic countries, so that policy issues such as climate change, inequality and corruption are more formally recognized and curbed at a policy level.

It will be a bumpy road politically, but the flourishing of protests around the world shows that something profound is occurring.

Have a great week ahead,

Mike

Ne vous mêlez pas du pain

Food set to become a controversial geopolitical issue

‘Ne vous mêlez pas du pain’ – do not meddle with bread, is the sound advice that Anne Robert Turgot, the 18th century French economic thinker and administrator gave to Louis XVI. It was good advice, which the King did not heed.

Turgot knew better, he was Controller General of Finances in France between 1774-1776, a period marked by the ‘Flour Wars’ when bad harvests pushed up the price of grain, and consequently, bread. The riots were a precursor to the Revolution, at a time when nearly half of disposable income was spent on basic foods like bread (and salt).

The link between food prices and unrest has held since then (and has a pedigree going back to and beyond the Roman Empire). In 2007 as dollar and commodity price volatility marked the beginning of the global financial crisis, a spike in soft (agricultural) commodities led to unrest in countries as diverse as Haiti, Mozambique and Bangladesh.

Then four years later, a spike in grain and other food prices catalyzed the Arab Spring, markedly so in Egypt which is highly vulnerable from the point food security. Some countries in the region, notably Kuwait, ducked such unrest by introducing grants and subsidising food consumption for over a year.  

The case of the Arab Spring underlines two other factors, both also found in the likes of Venezuela today. First, rising food prices are usually the ‘last straw’ for citizens in countries that are badly run, corrupt, suffer poor institutions and that are often also oppressive. Second, in many of these countries, as in pre-Revolutionary France, staple food stuffs like bread make up between one third to one half of discretionary spending.

This was the case in India in recent years, where spikes, or more appropriately bubbles in onion prices led to political agitation. For example, in mid 2013 there was fivefold spike in the price on onions, partly due to shortages, partly due to hoarding. Similar, dramatic spikes have occurred to garlic prices in China.

Since that period (2012-2013) world food prices have thankfully been stable, according to the UN FAO global food price index. One area of recent turbulence which is worth watching is pork prices in China. Swine fever has led to a sharp rise in the price of pork, which because foodstuffs account for some 30% of China’s inflation basket, has driven CPI (consumer price inflation) to 3%, close to its highs of the last eight years.

While China is not at all as fragile as Egypt, the spike in pork prices if it persists, will have a number of short and longer term macro impacts, one of which is that China may not have the demand for the 20 billion dollars or so of soya beans it has promised to purchase from the USA.

Chinese consumers will feel more constrained, and the rise in prices will, in the context of weaker property prices, contribute to a sense of ‘squeeze’ (recall the phrase ‘squeezed middle’ (class) in England). Relatedly, higher headline inflation makes it more difficult for the People’s Bank of China to cushion weakness in the economy with rate cuts.

The spike in pork prices is also a reminder of how food is at the centre of geopolitics. China, though vast, has a relatively constrained arable land mass, and will in the future have to import more food as well as try to buy land or crop facilities in other countries. Other food ‘vulnerable’ countries are India, Indonesia, the Democratic Republic of Congo (DRC), Bangladesh, Pakistan, and Ethiopia. Global warming and diminishing water supplies in many of these countries may mean that food security becomes an even more acute risk factor.

In contrast, the US has vast expanses of farmland, a good chunk of which could be used for food stuffs if it were not for ethanol subsidies. In the future, it may use food in an altogether more strategic way.

In the shorter term, the investment impact of higher pork prices is to make Chinese consumers nervier, to constrain policy makers there.  That means that demand for hard commodities like oil and copper will be muted, Chinese interest rates volatile and overseas food producers more attractive.

Further out, trade wars may give way to food wars.

Have a great week ahead,
Mike

Lessons from Brexit, so far

Brexit, washed away

In the past week a short video clip of Laurel and Hardy’s struggle to get away on holiday, under the title ‘How England plan to leave the EU’, has gone viral (especially so in the German speaking world). Whilst an uncharitable view, European leaders are as I write, discussing a second Brexit extension, and the prospect of a Christmas general election in Britain is now high.

In my view the first part of Brexit is almost over, in the sense that terms now seem to have been agreed between the EU and London. The potential scenarios are now narrowing, and point towards a less disruptive form of Brexit in the near future. Against that backdrop, where I caveat plenty can go wrong, it is time to begin to draw some lessons from Brexit, especially as other parts of the world become more agitated.

In many respects Brexit is a global event because it was the first rupture in a world where the liberal order is being levelled, and where a sense of the fractured and chaos are now normal. The second such rupture was the election of Donald Trump, and today events in Hong Kong, Chile and Syria illustrate the emerging democratic, economic and geopolitical faultlines, where American policy in particular will be tested.

The savage and unpredictable political process that is Brexit has produced very few winners, but for observers outside the UK there are clear lessons.

One, which is ever important ahead of the 2020 election, is that unless issues like immigration, national identity austerity, declining human development (think education attainment and healthcare standards) are correctly channeled, they will destroy a nation. Britain is bitterly divided because of Brexit, as is the US by Donald Trump.

In Britain, previously sacrosanct roles such as that of the Queen, the functioning of Parliament and the Constitution has been pushed to breaking point, as it should be said, has any sense of ‘truth’ in politics. Like America, Britain’s checks and balances are just about holding up. That few political leaders today could pen something like the Federalist Papers is just one reason for Americans to revere its constitutional heritage. Hong Kong, and arguably the increasingly ‘managed democracies’ of Eastern Europe echo this tension.

Geopolitically, the European Union (EU) has emerged from Brexit with the lesson that when it is united, its size and technocracy are formidable. For all the castigation of the EU by British politicians, it has thoroughly outclassed London. The White House should take notice of this in case it considers a trade war with the EU.

In Brussels today, where a new Commission is soon to take office, Brexit is becoming a side issue and there is more and more attention being paid to the role that the EU needs to play in a multipolar world. Here it is stealing a march on the US and China, in two respects. The values of liberal democracy are more consistently being enunciated by European leaders, and the EU is fast becoming the first mover in setting the rules and regulations that govern new technologies.

More locally, one of the dramatic side-effects of Brexit is the way it has detonated the historic relationships between Ireland, England and Scotland. Scotland will very likely become an independent state in five years time, there is growing talk of a united Ireland, and Ireland itself will be the only EU country with strong cultural ties to the USA.

What happens to Scotland and Northern Ireland is a key part of the next chapter of Brexit. Scotland will need to think more clearly about its economic model as an independent country, and on the merits of being an EU member. Northern Ireland, whose socio-economic problems have long been neglected by London, arguably needs a Marshall style plan to transform its economy which is heavily dependent on state disbursements, and that needs to follow the example of social investment in countries like Sweden and Switzerland.

Then finally, what Britain (effectively England) does next after Brexit will be a vital lead indicator of where other countries can go in a world where globalization is being levelled out. One avenue is a purgatory of post Brexit recrimination, a lack of leadership to tackle underinvestment and a susceptibility to nationalism.

Another, more optimistic one that could reflect the best instincts of Britain is that a new generation of political leaders comes through to replace the likes of Boris Johnson and Jeremy Corbyn. They would then begin to tackle the many policy issues that have been given little thought as Brexit has raged on – the need for the UK to develop a new economic model especially one that focuses on the potential of its regions, what role the UK plays as a mid-sized geo-political power and the need to focus policy much more on human development issues like mental health and education.

You never know, the same might just happen beyond the shores of the UK.

Have a great week ahead,

Mike

The Dude, Don and the dollar

Diplomacy, Trump style

In an increasingly fractured world there are still some things that unit the most disparate countries. In recent years a trader, named ‘the Dude’, has popped up in Turkey’s financial markets. ‘The Dude’ has been known to trade in huge volumes, on occasions boosting the average volume of the Istanbul Exchange by up to 10%.

He came to mind last week after I read William Cohan’s fascinating article in Vanity Fair where he detailed a range of enormous trades in the S&P futures market that appear to have taken place just before market moving tweets from the US President. Regular market participants have been left flummoxed by the size and prescience of these trades, and it is to be hoped that the market regulator will get to the bottom of the matter. However, one cannot help pondering the identity of these ‘Dude’ like traders.

Beyond trading, there is oddly, much ore that unites Turkey and the USA. Turkey has become the graveyard of US diplomacy as the sanctioning of the Turkish army’s incursion into northern Syria by President Trump arks the end of the moral, democratic and military backstop that American has extended to the rest of the world for the past seventy years.

That Mikes Pence and Pompeo have only managed to agree a stay of execution for the Kurds illustrates the atrophying in American power, and the schoolboy-ish letter that President Trump sent to his Turkish counterpart makes matters even worse.  

Economically, Turkey has two interrelated lessons for the USA and the rest of the world. First, Turkey is a salient tale in the rise and fall of nations. Since the early 2000’s when Kemal Dervis had righted the banking system and the prospect of membership of the EU was dangled in front of it, Turkey made great progress. Lately this has come to a halt as policy making, the quality of institutions and the rule of law have been degraded.

It leads me to think of Edward Gibbon’s ‘A History of the Decline and Fall of the Roman Empire.’ Gibbon, who sought to explain why the Roman Empire disintegrated believed that Rome became complacent, institutions weakened and the leaders in Roman public life lost their sense of civic virtue (or what Machiavelli later simply called ‘virtu’ – the good of the republic or common good).

The importance of institutional quality and the need for a sense of civic ethic is evident in other books that track the rise and fall of nations such as Acemoglu and Robinson’s ‘Why Nation’s Fail?’.

Acemoglu, like Dani Rodrik, is one of the leading economists in the world, and Turkish. Both of them I am sure, lament the direction that their country has taken, and both would have clear policy answers to set it back on course. Both are based in Boston, and it is hard not to think that their work (Acemoglu and Robinson have a new book out, ‘The Narrow Corridor’), as well of course as that of Gibbon, deserves reading in Washington.

It might also be more widely read on Wall Street, because as Turkey again shows, political risk is becoming a greater force in markets. Typically, and doubly so in the age of quantitative easing (QE), political and geopolitical risk have not played a significant role in developed economy markets.  The behavior of the Turkish lira, its debt and equity markets in the past three years suggests that for emerging markets at least, political risk is now a dominant market factor.

The case of Brexit and sterling suggest that developed markets are not immune. The perplexing issue however, is how investors (at least those who, to go back to William Cohan’s article, do not have premonitions of market turning tweets) can react to heightened policy uncertainty.

The puzzle is deepened by the fact that number of measures of policy uncertainty are at all time highs, while volatility is close to its historic lows. Indeed, for most investors the political risk they are most concerned about is the prospect of an Elizabeth Warren Presidency, which whilst arguably good for American institutions could be tough on corporate profits and taxes.

Back to the current incumbent of the White House, who is attacking his country’s central bank and institutions with nearly the same vigour that Mr Erdogan is employing in Turkey.

The reason that the dollar is not as volatile as the lira is that it is the reserve currency in a reasonably healthy economy in a world where most other large economies are weak. For dollar based investors however, dollar strength is a good opportunity to diversify, especially for those who think that the ‘American empire’ has peaked. In the shorter term, hedges such as gold and equity volatility, are beginning to look more attractive. If the ‘Dude’ sized trader in the S&P futures market is found out, they may be doubly interesting.  

Have a great week ahead,

Mike

Hamilton would have a plan for Brexit

Neither Leave nor Remain, but go forward

This article is published by the excellent UnHerd.com, https://unherd.com/2019/10/alexander-hamilton-rap-star-nation-builder/

The fracturing of the world order by events such as Brexit, and the growing consensus that we ‘live in interesting times’ mean that today is a busy and stimulating time for those who enjoy drawing historical comparisons with the present.

One particular strand is the manner in which some have drawn upon America’s Revolution as philosophical support for Britain taking back control from Europe. Others have gone further. The former Tory minister and now Brexit Party MEP Ann Widdicombe, in her maiden European Parliament speech cast Brexit as ‘oppressed people rising against oppressors, colonies rising against empires‘.

The idea that Britain is emasculated by Brussels in the way a colonial vassal state might be is scarcely believable, especially so when heard from Dublin, Belfast, Edinburgh and likely much of the Commonwealth. Breaking free from Brussels will not solve the many issues facing Britain, but it may eventually crystalize a serious debate on the future.

When this happens, the example of the Founding Fathers, and especially one of their leading lights Alexander Hamilton, will be worth delving into. From this point, Britons can choose between the purgatory of Brexit or alternatively they can agree that a long period of rebuilding is called for. If this is the case, Alexander Hamilton is very much the man to listen to.

Hamilton was a man of many achievements – a talented military officer and aide to George Washington, a driver and interpreter (through the Federalist Papers) of the US Constitution and the first Secretary of the Treasury, to list just a few accomplishments.

Today, interest in Hamilton has undergone a revival, thanks in part to the musical bearing his name, even if it does not reflect all of his achievements. Hamilton stands out as someone who planned, established, and built many of the important institutions of the United States.

He had a hand in the creation of its currency framework; in the foundation of the Treasury, a prototype central bank (the Bank of the United States), the Coast Guard, and West Point; and in the structuring of the army. He was also a mastermind of American foreign policy and its trade relationship with Britain.

He was also one of the lead authors of the Federalist Papers, the collection of essays that sought to clarify, strengthen, and promote the US Constitution. Few men or women have had as enduring an impact on their nation. Brexit would be easy if its proponents had the foresight to create their own ‘Federalist Papers’, or ‘Brexit Papers’.

In my view, the many achievements of Hamilton make him shorthand for the establishment of the institutions, laws, and skill sets needed for countries and regions to be able to thrive, in the sense of enjoying durable economic growth, high human development, and a stable public life. All of these factors are on the wane in Britain and the wider world today and need to be revived.

In the last chapter of ‘The Levelling’ called ‘The Hamilton Project’ I ask a notional Hamilton what advice he would give to the EU, the US and China in order that each prospers in the 21st century. For instance, he would advise the US to take the lead in crafting the laws and frameworks needed to marshal new technologies like gene editing and cyberwarfare.

In that context, there are a number of things that Britain can learn from Hamilton, notably the way he conducted politics and the way he thought about nation-states and government.

To start with the conduct of public life, and mindful of the consequences of the Johnson government’s approach to politics, the nascent democracy within which Hamilton acted was a noisy, nasty and chaotic as the Brexit climate is today. Hamilton’s enemies used the press ruthlessly against him. For his part he was careful that the will of the people be channeled by institutions and laws, and that ‘fake’ views of his policies be rebutted.

He was diligent in seeking out political opponents and seeking to convince them of his views. The conciliatory and relatively open way Hamilton and others built a consensus over the Constitutional Convention is a model for relations across the British political spectrum, as well as relations between London and Brussels, should be handled.

That they are not is in part a question of leadership, and the quality of this particular political generation. Hamilton and the Founding Fathers are the benchmark for political classes worldwide in terms of their vision, comportment and the durability of their policies.

In time, it may be that Brexit catalyses a new generation of politicians and potentially parties and that this ‘next generation’ is the one to shape what ‘Global Britain’ becomes.

Here, Hamilton would also be a useful guide. He might set the scene by counselling that, as the trade war between the US and China is showing, a globalized world is ceding to a multipolar one where Britain will simply be a mid-sized power like South Korea and Australia.

The notion of Global Britain will need to be conceived in the context of this reality, with implications for corporate governance, tax laws, the legal system and the City. It may also mean that Global Britain is founded on a meaningful security and defence agreement between the UK and the EU.

Hamilton would then focus on at least two other areas – both at the centre of the Brexit vote. One is low, poorly distributed economic growth and the other is immigration.

Trend economic growth in the UK as proxied by productivity has slowed dramatically and has become too financialized in the sense that it has increasingly relied on the accumulation of debt and priming by central banks to keep it going. The distraction of Brexit has meant that there has been too little attention paid to the rattling engine room of the economy. It has been hollowed out by austerity and the labour market has changed radically for the worse in terms of the way workers have exchanged flexibility for security.

What debate there has been so far has focused on redistributive measures, a difficult policy to execute ahead of a likely world recession. What is much more important is to rediscover the source of high, organic economic growth.

The secret sauce of ‘growth’ lies in many of the things Hamilton developed and that equally Britain is well known for – education, good institutions and laws. If he were with us today, Hamilton would lay out a plan to boost human development (education, longevity, mental health and equality), and to harness the parts of ‘intangible infrastructure’ (e.g. education, socially friendly use of technology, rule of law) that Britain is good at.

Then given the uncertainty, animosity and opportunity afforded by Brexit, Hamilton might propose a very clear contract on immigration. The aim of this would be to lay out the conditions that immigrants are welcomed into Britain, the help given to them to settle, assimilate and find work, their rights in the UK and a framework that would ensure they are respected and integrated into British society.

Given his aptitude for the infrastructure of state, Hamilton could not neglect Scotland and Northern Ireland. He would recommend a Marshall style fund to help reshape Northern Ireland’s economy and society, with the implementation of this to be carried out by countries like Sweden and Switzerland who excel in public policy. For Scotland Hamilton’s work on currencies and state banks will come in handy as independence becomes a reality.

Much if not all of the media is obsessed with the very short-term drama, and to an extent who could blame them such is the entertainment value. However, attention needs to be drawn to the deeper issues facing Britain and the potential solutions to them if Britain is to truly prosper and be at peace with itself after Brexit. Sometimes, history and historical figures can anchor and steer these debates. I would urge Britons to look beyond usual historical references like Churchill to Alexander Hamilton. He embodies the idea of nation building.

His view would be that Brexit is simply a manifestation of decline and that this can be reversed by honestly locating Britain’s place in the emerging multipolar order of the 21st century, by developing a new ‘contract’ with immigrants and most importantly by rediscovering the sources of organic economic growth.