The ESG Paradox

The departure of Donald Trump from the political stage has left a void of sorts in the flow of lurid and dramatic media. But this is a void that the financial industry seems keen to fill. Since January we have witnessed a crypto mania, Reddit craze, and the blow up of two investment funds (Greensill in Europe and Archegos on Wall St), to mention a few spectaculars.

This comes at a time when one of the most significant trends in the financial services industry is the rise of ESG (Environment, Social and Governance) investing, whose ostensible aim is to channel capital towards companies that are environmentally friendly, socially responsible and good governance.  The investor reaction to the Deliveroo initial public offering in London and the coming into force of the EU’s SFDR regime suggest that ESG focused investing is becoming more meaningful.

However, there is still an intrinsic contradiction in the behaviour of parts of the financial services industry and their efforts to sell trillions of euros in ESG products to investors and clients. Without being overly cynical, this incongruity is driven by incentives – the attraction of ESG as a cottage industry career path, and as one where as far as exchange traded funds are concerned for example, fees are higher than for plain vanilla products.

There is also a data problem. The ‘E’ part of ESG is a relatively data rich area and one where a firm’s climate impact is increasingly straightforward to capture. The quality of corporate social responsibility and governance are harder to capture, and much of the data collected by research firms that measure ESG comes directly from the companies being scrutinized and therefore susceptible to ‘greenwashing’.

While some new ESG ratings companies such as Equileap are trying to rectify this (from the point of view of gender equality) there are other vulnerabilities in the investor practice of ESG, most notably in investor voting on issues like pay and governance, which across the board is mild-mannered at best, and is not activist enough.

One overlooked aspect of ESG is that it is highly coloured by regional and national cultures. American corporates are more focused on the ‘S’ part of ESG, Europeans it seems focus on the ‘E’ part while the ‘G’ element is most important to emerging market investors. In general, corporate performance on ESG criteria is clustered in progressive countries – the Netherlands, Nordics and New Zealand for instance.

Against that backdrop, we need to ask whether there are ways to gauge what financial services firms are sincere when selling us ESG and ‘Impact’ funds, and generally preaching that they are ‘doing God’s work’. There are maybe three rules of thumb here.

The first, echoing Harry Truman’s desire for a ‘one handed economist’ is that the ‘left hand’ and the ‘right hand’ of a financial institution must be philosophically ‘joined up’ in the sense of being consistent in the ethics of what they do. Too many banks or asset managers have one division that pronounce the sanctity of their ESG or Impact efforts, and another that runs banking deals in extractive industries, pumps over priced investment funds or over-allocates to flawed enterprises (Wirecard was an example). 

Secondly, efforts to boost a financial institutions’ social responsibility need to permeate an entire institution, and its customers. There is little point in banks (one of the least female friendly industries) responding to gender equality by adding women to its board if issues like pay equality, childcare and sexual harassment are not fully addressed through organisations. Equally, there is a good deal of survey evidence to show that banks do a poor job of addressing the financial needs of women as customers.

The third area to examine is regulation and central banking. Since especially the financial crisis regulators have acquired a reputation for arriving late at the scene of banking accidents. Arguably one mistake they have made is to focus on disciplining corporate entities, in terms of fines, rather than individual bankers. A change in the burden of accountability towards irresponsible individuals would likely curb risk taking.

Related to this is the vogue on the part of central banks to try to solve the ‘E’ and ‘S’ parts of the ESG problem set. Whilst at the Fed, Janet Yellen nobly made reducing longterm unemployment a policy focus. In Europe, the ECB now talks about its role in spurring the green economy. While it is good to see central banks ‘caring’, the great danger is that the more active they become in say trying to change society, the more generous they become in monetary policy, and eventually, the more inflation and banking accidents we endure.

Have a great week ahead,


Ever Stuck in the Great Lockdown

Ever Stuck

The encumbering of the supertanker MV Ever Given in the Suez Canal is the image of the week, or perhaps the year. It speaks to a world economy that has overgrown its natural infrastructure – a vessel greedily stacked with cargo that becomes so unwieldy that it is grounded by a puff of wind (high winds and a dust storm did for the Ever Given). It takes little imagination to think of problems like climate change and inequality taking the place of the tanker in the channel of the world order.

It is also an image that brings home the tangible elements of globalization – as I write 300 ships are stuck behind the Ever Given (at a cost of USD 400mn per hour), and their delayed passage through the Suez Canal will deprive people of vital goods, like toilet paper.

Besides demonstrating what a ‘house of cards’ globalization has become, the grounding of the ship echoes with other supply chain blockages – consider the deprivation of Parisians now that a supply of decent sausages, clotted cream and cheddar is cut off from the continent by Brexit (Marks and Spencer shelves are bare!) or the fact that the fortunes of the semiconductor industry are concentrated in a few hands, with chip shortages rippling through other industries (Volkswagen will produce 100,000 fewer cars because of chip shortages).

We could write off the various supply chain shortages, especially the unfortunate Ever Given, to a continuation of ‘2020’ style bad luck. Indeed, we might even blame COVID on supply chains as some analysts have traced the initial European human-to-human infections to Starnberg in Germany, where a local car parts supplier (Webasto) organized a training session with a Chinese colleague from its operation in Wuhan!

Before we shout ‘down with supply chains’, consider that they have proven both durable and complex over the course of the last year, having been stress tested by Donald Trump, tilted by the rise in new technologies (especially data management) and the ups and downs of the post COVID recovery.

The crisscrossing web of supply chains is the fabric of the global economy, but it is emerging from the COVID crisis in a different shape. Consider two of the themes I have referred to in recent weeks – the post COVID ‘Decameron’ effect (that new, good trends are born out of a pandemic driven economic crisis) and the ‘scramble for rare places’.

Take the scramble for rare places (and rare materials) first. This trend will place a premium on supply chains and could exacerbate blockages. To underline this – and indeed to emphasis that risk to China/US relations comes from a real war rather than a mere trade war under President Trump – twenty Chinese fighter jets (including four nuclear capable bombers) flew into Taiwanese airspace on Friday. Taiwan is the locus of the world’s semiconductor industry (one of the few technologies China has not mastered) and any disruption of it would lay bare supply chains.

It might also echo the work of Norman Angell, a Nobel Peace Prize winner in 1933 and author of ’The Great Illusion’(1909).He argued that the buildup of great navies risked a world war that this would not likely happen because international economies were so interdependent. The war did happen.

Tensions in the South China Sea emphasise how in the future supply chain rollout will be driven not only by economic imperatives, but also by the twin ideas of national security and strategic autonomy. The restriction of vaccine exports from Europe and India is a good example. Increasingly, new industrial capacity will be located in geopolitically friendly locations – Intel announced a USD 20bn investment last week in two new facilities in Arizona, additional capacity in Ireland and more contracts for partner firms in Taiwan and South Korea.

The other consideration is the ‘Decameron’ effect. Every major macro dislocation in the last two centuries – from the global financial crisis to the aftermath of the Great War, has been met with a variety of fiscal, monetary and institutional responses. This time should be no different and the ‘Great Lockdown’ (Harold James’ term) is being met by a barrage of fiscal activity (with monetary support), though undercut by a real absence of collaboration across counties.

The next phase in this will be an infrastructure plan announced by President Biden next week. The imperative here will be to upgrade infrastructure across the US – which lags other countries badly (airports, telecoms, fast trains for instance). The plan may also look to link the more closely with South America and Canada, such that it builds out the backbone of a regional infrastructure.

There are other budding infrastructure networks – such as a planned trade infrastructure between Israel and the UAE, a busier night train network across Europe and multiple plans for drone and air taxi networks give a glimpse of the future. If possible, we might also spare a few shovels for the Ever Given.

Have a great week ahead


Return of the Prodigal Economy

42,000 years ago the magnetic poles of the Earth reversed, causing a hugely destabilizing climate disaster. The event provoked a series of environmental shocks that today could only be captured by the most wildly imaginative Hollywood director – chaotic weather patterns, a smashing of the ozone layer, intimidatingly large ice sheets and ripping solar winds.

By analyzing the rings of New Zealand swamp kauri trees scientists have modelled some of the conditions and potential side-effects of this jolt to the Earth’s magnetic field ( For instance, Neanderthals and many large species were wiped out and humans would likely have sought shelter in caves.

Though this fascinating story tallies with my recent Mars focused missive, it maybe strangely, had me thinking about the bond market. In many ways, the bond market is the magnetic field of the financial system – when it is destabilised, other markets and broad economies suffer.

Its financial and economic power is legendary, so much so that when something happens in the bond market commentators dust off quotes about ‘bond vigilantes’ or James Carville’s (political adviser to Bill Clinton) that if reincarnated he would like to return ‘as the bond market …because you can intimidate everybody’.

The bond market has largely been dormant for much of the past ten years, because inflation has been feeble and central banks have continued to hoover up the supply of bonds. Some issues, such as Austrian 100-year bonds have been stellar performers, but in the course of the past month have fallen by over 20%, a shock to the risk averse type of investors who hold these instruments.

More importantly, the US 10-year bond yield – the lynchpin of the global system – rose from 1% at the end of February to 1.63% this week, a move that is historically rapid and significantly large, even if yield levels are still low. Contrast the ECB’s odd comment that it was ‘monitoring’ yield moves even though many euro zone bond yields are negative, with the advice textbooks (up till 2010) gave that 3.5% was a good benchmark for the 10-year yield.

The move in bonds is significant in at least four respects. First, it has checked the dizzying ride higher in equity and credit markets and in the near future should make these markets more two sided. In particular technology stocks whose valuation multiples are sensitive to the level of yields have suffered while banks, whose business model is bolstered by higher yields, have done well.

Secondly, the rise in yields is a mini revolt of sorts against central bank policy. Third, it reminds us that should interest rates rise further, the colossal load of debt that hangs over the world economy could become existentially dangerous.

So far what has been interesting is that while bond yields (even adjusted for inflation expectations, or real yields) have risen, credit risk has been very well behaved. Should the level of bond yields rise further (to 1.65% and above for the US 10 yr) then this will create problems for leveraged investors and leveraged companies.

The fourth germane point is inflation. Like a long-lost friend, we haven’t seen inflation in quite some time – or so headline inflation indicators tell us (consumer price inflation in the USA is 1.3%). Many people forecast that with a triple whammy of the ‘end of COVID’, huge stimulus packages and easy central bank monetary policy we will see a surge in spending and therefore inflation (notwithstanding the taming effects that demographics and technology have on inflation).  

For the moment inflation is everywhere, except in the official inflation figures (it is beginning to show up in producer prices though). Inflation expectations, as measured by markets are high and rising however (close to 2.5%) and there is a generalized sense that inflation has been redirected into asset prices rather than consumer goods.

This phenomenon is more easily understood if we consider that survey’s report that half of 25–34 year-old Americans plan to put the money from their stimulus checks into the stock market. Treasury Secretary Yellen has been largely silent on this though I can’t imagine that any of her close academic economist friends from Joe Stiglitz to her husband George Akerlof would regard this use of ‘stimmy’ checks as economically productive. To that end, Yellen might surprise us by introducing some sort of transaction tax or tweak to capital gains, or more simply try to prompt changes in margin requirements.

The other pressing issue is how central banks will react to both rising yields and the likelihood that inflation is finally materializing. An overt reaction to yields in the shape of a ‘yield curve control’ policy (keep long duration bond yields low) would likely set off a powerful rally in technology stocks. What is more likely is that central bankers will ‘whistle past the graveyard’ of inflation in the sense of publicly denying its existence, though privately fearing that eventuality. If we were to get an inflation shock, small and momentary as it might be, then central bankers may have to maneuver into a very difficult policy change.  

This may be some way off. However, the ‘prodigal’ phenomenon of higher bond yields is here to stay especially if the velocity of money picks up. Like a jolt to the magnetic pole of the Earth, this new market regime will have wide ranging implications. With debt, stocks and housing all expensive, a breach higher in yields might have us all living in caves too.

Have a great week ahead


Curing Politics


In my Christmas missive I sketched out a number of ‘surprise’ events that might occur in 2021, one of which was that

As part of its policy of ‘national strategic autonomy’ France opts to favour two French made vaccines for its citizens, but adverse reactions lead to a health and political crisis. Emmanuel Macron’s standing drops in the opinion polls, and the French establishment search for a centre right candidate for 2022’.

Though I wrote the note under the jovial banner ‘Drinking with Dickens’, I have to adhere to the first rule of forecasting which is to loudly take credit for any prediction that is mildly correct.

France, like much of the EU, is struggling to distribute COVID vaccines and shows little sign of lifting lockdown restrictions. To be fair, much of the blame for the slow rollout of vaccines rests with the odd modus operandi of Ursula von der Leyen’s cabinet.

The French situation is however compounded by Emmanuel Macron’s attack on the Astrazeneca/Oxford vaccine, 1 million vials of which lie unused in France, and by the failure so far of French scientists and pharmaceutical companies to speedily come up with a French ‘cure’ like that of fusty old Oxford (by the way Oxford has 72 ‘affiliated’ Nobel Prizes to 70 for France).

In the end it looks like Europe’s quest for ‘strategic autonomy’ (a French concept) and its admirable desire to implement a European solution to the vaccine problem, that got in the way. This unity is now crumbling – small, states Austria and Finland want to join forces with Israel, and Italy has intervened to stop the export of vaccines to Australia. As with the initial months of the COVID crisis, countries are beginning to fail the ‘solidarity’ text, which is not a great sign for the international order.

All of this begs at least two questions – do we yet have any sense as to what ‘type’ of country has managed to best deal with the COVID crisis, and second what the political implications and fallout of COVID (especially for Emmanuel Macron) are.

First, at the beginning of the crisis it seemed that countries that had experienced a pandemic in the recent past (Asia), and those with robust social democracies (small, advanced economies and Germany) dealt best with the fallout from the coronavirus, whilst the Anglo-Saxon countries (and diverse others) did less well. The UK and the US, together with Israel and the UAE of course, have now done much better with vaccination programs.

This disparity in performance, with countries like India confusing the picture even more, will try policy students for some time. One of the better explanations I have heard is from David Skilling who makes the distinction between liberal market economies (LMEs) and coordinated market economies (CMEs).  LMEs use decentralised, competitive and flexible market mechanisms; CMEs rely more on established informal, relational arrangements between a range of stakeholders. In that context, the liberal market economies were quicker to organise supplies of vaccines and to distribute them.

We could spend a great deal of time debating which model is better – but it is a redundant conversation because changing a country from an LME to an CME, takes a great deal of time, and to quote the Skilling paper the race against COVID is a marathon, not a sprint’ (

What is more pertinent is how countries are set up for the next challenges – the potential for political unrest amidst enduring lockdowns (uncharacteristically Ireland witnessed a small but violent ‘anti-lockdown’ protest last week), the possibility of a large number of broken small businesses, the need to rethink how healthcare services can be made flexible, more focused on mental health and better funded on a permanent basis, and how the ‘scramble’ I referred to last week where numerous countries are chasing strategic assets, will distort supply chains and inevitably lead to new disputes.

Given that task list, who would be a politician? Back to my speculative comment on Macron. First, I find that commentators outside France regularly overestimate the chances that he might be de-throned, and that Marine Le Pen might take his place. In my view Macron’s greatest failing during the COVID crisis (and most leaders have been tripped up by it) is his failure to be ‘close’ to the French people during the crisis to the extent that his ‘Jupiterean’ stance may become a liability.

To that end, if he is displaced (I don’t think so) it will not be someone from the right (General de Villiers, Philippe Juvin or Le Pen) but rather a centrist who is more avuncular (Edouard Philippe or Michel Barnier). On the left, my bet is that their leading candidate will be Annie Hidalgo as a modernising/eco/egalitarian candidate. There is still lots of time to go till the next French election, but in the light of the post-Merkel world, it will matter hugely for Europe.

On a broader landscape, by the time we get to mid 2022, the political topics that preoccupy us will be changing. While tackling inequality (especially in the US) will be prominent, politicians and societies will be dealing with an environment that is ‘the opposite of confinement’ in the sense of people’s desire to socialise and travel, the potential headwinds of higher interest rates and higher prices, and ongoing challenges to the democratic model (Freedom House’s latest report highlights just how vulnerable democracy is).

On that note, my credit goes to the French judiciary who have now tried and passed sentence on two of the previous three presidents, and in doing so uphold the credibility of the republic. Other countries might examine this example when it comes to the conduct of their (former) presidents and prime ministers.

Have a great week ahead,


The Scramble for Rare Places

Mars is calm compared to Earth

One of the more surprising things someone said to me in recent years was that ‘Ireland has a decent space industry’. The fact that the comment came from the head of the space agency of a large European country, and we were sitting together in a bus in the Middle East adds some lustre to the observation.

There is a budding space industry in Ireland, to match its large aircraft sector and this had me wondering whether someday Ireland will send a man or woman to Mars!

The images that NASA’s Perseverance probe have sent back to earth reinforce the sense of wonder created by previous probes (about ten craft or probes have landed on Mars) and remind us of both the power of technology and the possibilities that space opens up.    

While the Perseverance ‘trip’ cost close to a total of USD 3bn and the journey lasted about seven months, a human voyage to Mars is estimated to cost closer to USD 500bn and depending on the corresponding orbits of the earth and Mars, between seven to nine months.

It was thought that the mental toll of spending seven months cramped in a space craft would be too much for even well trained astronauts, but following the COVID-19 confinement, you might say we are all astronauts now! Until someone is courageous enough to make the journey, we will see more and more robots visit Mars, and more interesting experiments such as attempts to grow plants on Mars and to develop oxygen machines fit for use on Mars.  

With NASA very much to the forefront in landing rovers on Mars, a number of countries are also in the process of executing or planning missions to Mars – Japan, India, the EU are chief amongst them. Russia first drew up plans to send humans to Mars in the 1960’s, and China is expected to land a probe on Mars in May whilst the UAE is a new player with its Amal probe. A number of private companies – SpaceX being prominent – are also getting in on the space exploration (and commerce) game.

The race for space is potentially part of a bigger trend which I will call the ‘scramble for rare places’. This is taking various forms – a race for safe parts of the planet such as the notional billionaire’s New Zealand mountain lair (please do watch the film ‘Goodbye to 2020’…and New Zealand also has a space industry), a race for space and the scientific and mineral gains this may produce, a race for the deep oceans and relatedly a race for the Arctic.

In particular the Arctic is interesting – it is overseen by the Arctic Council (Canada, Finland, Iceland, Sweden, Norway, Russia, the United States and Denmark) for its strategic location, its role as a gauge of climate damage and relatedly the opening up of shipping routes by melting ice.

Geopolitically it is a vital place – a Russian submarine planted a Russian flag under the Arctic in 2007 (interestingly Russia’s leading Arctic scientist has been charged with spying for China), and Denmark has recently acted to beef up its military presence in the Faroe Islands and Greenland.

Reflecting Thomas Pakenham’s book ‘The Scramble for Africa’ (which is happening again by the way) the scramble for rare places has a strong strategic impetus, has dubious ecological side-effects and may ultimately have serious negative side-effects (again, an understatement in the case of Africa).

This ‘scramble’ reflects a world where cooperation between nations is becoming increasingly strained, where large chunks of economic activity are dependent on select natural resources (rare earths) and where, in some parts, rules of the game (space and the Arctic) are not open to interpretation.

To draw in the thread of last week’s note, it also reflects great power ‘Great Games’ on steroids. In the Great Game of the 19th century British and Russian spies crossed paths in Isfahan and Bukhara, now they will orbit each other around Mars, glide past each other in sub-Arctic mini submarines, or meet on exclusive ranches on the Argentine plains.

Like the Great Game, it’s all potentially fascinating but likely costly too.

Have a great week ahead,


Towards Evil Empires

The upturn in the world economy and the assured arrival in power of the Biden administration will have many commentators pondering as to whether globalization is back, after a violent interregnum during the Trump years.

As regular readers know, I believe globalization is finished. To take trade as an example, if trade bounces back it will have changed in two important ways, both of which make the world less interdependent.

First, trade and state led investment will be driven by the notion of ‘strategic autonomy’ – that they should be structured so as to reinforce a country’s geopolitical power as well as its prosperity. Second, advances in technology and the corporate strategy lessons from the coronavirus crisis mean that business models can be more technology driven, more decentralized and arguably less labour intensive, something that may impact many south Asian countries.

Another important element is that the one aspect of globalization that many ignore is political.  Globalization happened because of a shift in political models – communism fell, and thereafter the ‘American’ model traversed the world (again especially Asia), the number of democracies rose, and human development improved manifestly across the world.

Yet, this sense of ‘one system’ is now at an end – the global financial crisis and the Trump Presidency have sapped its credibility. Moreover, globalization has not transformed the world politically in the image of the American model. Indeed, there is plenty of evidence to suggest that the flourish in ‘democracies’ has halted and is reversing. Take for example the the Economist Intelligence Unit’s Democracy Index which in 2020 fell to its lowest level since 2006, and with 70% of countries covered showing a deterioration in the quality of their democracy.

In this respect there are two vital cognitive errors that ‘Western’ commentators make. The first is to assume that all countries prioritise their economy over geopolitics and social needs – Russia shows that this is not the case. The second is to believe that economic progress will naturally beget a desire for democracy. China, and the relative success of its Communist Party show that this is not the case.

What is now important and noticeable is that more and more events are occurring that push back and check the liberal democratic model. The most prominent of these is the quenching of Hong Kong’s ‘two systems’, and event that bookends the fall of communism.  The failure of liberal democracies to support the pro-democracy movement in Belarus is another and is the dereliction of many world institutions such as the WHO (World Health Organisation).  

The abject failure of Josep Borrell’s diplomatic mission to Moscow and a surge in military posturing in and around the South China Sea (for example ‘scrambles’ of Japanese fighter jets are at a record, averaging three per day) also point to a hardening of political arteries.  

Against this backdrop, a new model is emerging to challenge that of liberal democracies and for the first time since Ronald Reagan bemoaned the ‘evil empire’, we have two competing ‘ways of government’. I call them the Levelling and Leviathan models, drawn from the mid 17th which was formative period for the emergence of the nation-state, elaboration of democracy and thinking on how government should work.  

The Levelling model (from the 17th century English movement who crafted the ‘Agreement of the People) is based on the popular rediscovery of liberal democracy in the light of all of the challenges our world throws at it – indebtedness, climate damage and the penetration of social media into mindsets. Most of Europe, including the UK and the Democratic Party in the USA and naturally the Biden administration are in this camp. Indeed, on Friday President Biden staked a claim to revitalise liberal democracy when he stated he would ‘make a strong and competent case that democracy is the model that can best meet the challenges of our time’.

On the other side, are the Leviathans – who following the sense of Thomas Hobbes’ 1651 book ‘Leviathan’ see the need for a ‘supreme’ actor to control a country’s fortunes and where its citizens enter into a bargain with that leader. China today is a ‘Leviathan’ – its citizens exchange liberty for prosperity and national prestige, and there are growing signs that its President covets a long, unchallenged (ask Jack Ma) period in power. Its not clear to me that Russia for instance is a ‘Leviathan’ country, given the lack of a cohesive national project and the lack of a real developmental contract between Vladimir Putin and his people.

A world defined by ‘recuperating liberal democracy’ and ‘tough managed democracy’ will have many implications. Rhetorically it will make the role of the likes of Joe Biden easier if he can frame world affairs along these lines. It may also force the debate on European values – eastern European states may be forced to give up the illusion that they can pick and choose the variety of democracy they adhere to.

Finally, the battle of the competing attractions of the ‘Leveller’ versus ‘Leviathan’ model will be played out across many emerging nations. Ethiopia is one such example, where an open economy and the beginnings of a stable polity were beginning to take hold but that has recently lurched towards a more controlling, and brutal style of government. Think also of Nigeria – where inequality is growing and where unrest could become a serious socio-political issue. Nigerians may soon ask themselves if they want to replicate China’s success or whether Britain is a model for them.

Have a great week ahead,


The Democratisation of Risk

One of my favourite descriptions of globalization comes from JM Keynes, who at the end of  the first wave of globalisation wrote (in Economic Consequences…)

‘The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and the new enterprises of any quarter of the world’

A modern day version might see Keynes driving a Tesla, speculating on Robinhood and paying for a new house with bitcoin, all whilst respecting confinement rules, obviously. It may not be as effortless as that, the Tesla might catch fire, the Robinhood account may crash or face a margin call and bitcoin may prove too volatile to do anything with.

The confluence of these finance centric eco-systems has led many people to hold that we are in an age of the democratization of finance – where platforms, tools and products are springing up that give the common man and woman access to the financial opportunities hitherto enjoyed by billionaire hedge fund managers.

This is not the case. Instead of the democratisation of finance, we are in an age of the democratisation of risk – where a range of risks, mostly arcane financial market ones, are increasingly distributed across retail investors. The issue is that the man or woman in the street, is unprepared for these risks. The other, finer point is that when many people across a population find they have the ‘same’ risk, and all react against it at the same time, dislocation occurs.

The news that Amsterdam has overtaken London as a financial trading hub reminds me that it in the 17th century it was a centre of financial innovation (William Goetzman’s book ‘Origins of Value’) and that innovations in finance follow a pattern where early investors and pioneers (especially those who own the infrastructure) do very well, asset prices rise in a parabolic way and this attracts the greater investing public (the democratisation phase), a crash or scandal ensues and regulators arrive late to the scene of the accident.

The derivatisation of the US housing market in the early 2000’s is a good example. Cheap financing meant people could afford more, and bigger houses, until the entire market collapsed.

The study of risk is now a large field. Bodies like the OECD produce a risk scorecard that countries can use in risk assessment, while a good number of institutional and hedge fund investors have become very good at risk management. The coronavirus crisis offers a particular lesson in risk assessment, crisis management and in risk absorption (through fiscal stimulus, the organisation of public services like healthcare and the provision of vaccines, not to mention human adaptability.

The tragic and dramatic experience the world has endured with the coronarvirus may – following on a chaotic Trump Presidency, Brexit and other catastrophes – convince many that the level of risk in the world has risen. I would say that it has not – though two risks loom very large – climate damage and indebtedness – and the factor that makes them distinct is that they are ‘democratisied’ or that they affect increasingly large numbers of people.

If there is a lesson here for politicians and policymakers it is not to permit the democratisation of the twin risks of indebtedness and climate damage (if you graph world average temperature relative to its long term average with world indebtedness relative to its average, the two lines fit nicely over each other).

The telling example was the response of euro-zone countries – notably Spain and Ireland – to their respective financial crises in 2011. In both cases bond market investors, and the eurozone itself, could have borne the risks associated with mounting indebtedness but, ultimately those risks were borne by government balance sheets, and by extension households.

Concretely, what I have in mind is perhaps two principles. That policy makers think not only in terms of the probability of specific risk event outcomes (i.e. from floods to wars) and their potential riskiness, but how those risk outcomes are distributed. Markets work like this – risks never go away, they are simply being continually redistributed across different investors and time frames.

The second element is that policy focuses more on realigning the risk of an event (e.g. polluters) with the fortunes of those who ‘produce’ that risk. In China, the former chairman of Huarong Asset Management was recently sentenced to death for gargantuan levels of corruption. This is accountability taken to extreme levels, but for the Biden administration and many governments in Europe, who foreswear a belief in ‘resets’, ‘stakeholder capitalism’ and ‘ESG’, the democratisation of risk is something they need to fight against.

Have a great week ahead


Sting like a bee

The euro is like a bumblebee. This is a mystery of nature because it shouldn’t fly but instead it does…after the financial crisis…the bumblebee would have to graduate to a real bee’ Mario Draghi, London 26/7/2012.

Mario Draghi’s ‘bumblebee thesis’ of the euro never got the attention it deserved, largely because a few minutes later in his speech he mouthed the words that he was ‘ready to do whatever it takes’, adding ‘believe me, it will be enough’.

That Draghi went from David Attenborough to Dirty Harry in a few minutes arguably saved the euro and transformed the ECB into a giant monetary battleship whose financial vortex swallowed all credit risk across the euro-zone.

Like Ben Bernanke in the USA, Draghi’s launching of an emergency policy also launched a mindset. In the USA Janet Yellen, and then Christine Lagarde in Frankfurt carried on down the road of intervention. As a result, Greece and Portugal no longer (for the moment) have to worry about paying interest on new government debt issues, whilst France has investors queuing up to pay it for the pleasure of partaking of its vast debt mountain (10 year yield of minus 0.25%).

Draghi’s ‘do whatever it takes’ became the glue that held the euro-zone together – to the extent that the coronavirus crisis failed to create another existential crisis of the euro. However, another side-effect of the ECB’s bond buying program is that it took the pressure off governments to enact the economic reforms that are much talked about in Brussels. Partly because of this eurozone capital markets reform has stalled, its banking sector is relatively weak (as evidenced in valuations) and most troubling of all, the trend growth rate of the euro-zone is too low for comfort.

Italy is a case in point. It is often excoriated by critics in London, Brussels or Berlin for its lack of reforms – the same critics often ignore the suppleness of the Italian political system, the relative steadiness of its fiscal situation and the strength and dynamism of the northern Italian economy. Having said that Italy is not regarded as a model to follow.

What is astonishing then, is the willingness of Mr Draghi to dive into the marmite of Italian politics, and in a way take on the consequences of his own monetary actions in accepting the mandate to become Italian Prime Minster (Yellen has done the same in the US). Though, at the time of writing he has not yet found the support to form a government, his move is a brave one.

It is also a great opportunity for Italy, and Europe. Mr Draghi is very capable (holding a PhD from MIT where former PM Conte had ‘refined his education’ near but not at New York University).

Draghi is also a leader, having manifestly convinced close colleagues, European leaders and many others to share his monetary odyssey. In a previous note I wondered if he might return to Italy to manage AS Roma or become President. The role of Prime Minister seems beneath him and it should be said, risky.

Italy has a history of having many prime ministers (now 30 in the last 73 years, and 37 from 1861 to 1921), with some of them like Mario Monti taking the role as a non-political technocrat. Part of me thinks that politics is no place for gentle technocrats, not perhaps for successful businesspeople (Silvio Berlusconi of course is the exception here).

In that way, Draghi will have to cultivate a style that sees him rise above the rise of everyday politics, not to mention the many populists amongst them, and try to connect with everyday Italians. I am no expert on Italian life but like many countries edging towards the end of the tragic COVID crisis, its people are in need of leadership and, an economic recovery. Again, my naïve, non-Italian perspective is that they can not do better than Draghi.

If Draghi had a policy wish list it might go as follows – boost the trend level of economic growth across Italy, upgrade its education system from schools to universities and transform Italy’s foreign policy stance to one that is less Russia friendly, more involved with Mediterranean neighbours like Greece.

His appointment may also help to mend Italy’s relationship with Brussels, by ensuring that it is represented by one of the most credible European politicians. Moreover, as the post Merkel era approaches, Draghi can become the dominant leader on the European political scene – he took over the Italian Treasury when Emmanuel Macron was a 14 year old school boy.

So, the surprise of 2021 could be Draghi (again) and a renaissance for Italy? I wish him the best of luck.

Have a great week ahead,


$GME = Goodbye Market Efficiency?

Reddit Rules?

My last two notes have been about bitcoin and the stock market, both of which have become perceptibly more volatile. This week continues the theme, betraying the fact that markets are the fulcrum of the intersection of social, technological and economic forces, and that two of the trends mentioned in my December 4th year ahead note – ‘empire builders’ (the creation of new wealth) and the ‘rise of new financial market ecosystems’ are now coming into focus.

The latest market dislocation is centred around a video game retailer called GameStop. GameStop’s share price traded at a level of $3 last April but hit $370 on Wednesday. During that period, GameStop’s underlying business has not changed much, possibly gotten worse. The new development lies in the dynamics of its share price.

Some hedge funds had sold its shares short (selling them now on the hope that they would buy them back at a lower price), however a cohort of retail investors who apparently managed to ‘synchronise’ their trading views on the social media platform Reddit, aggressively bought shares and options on GameStop, creating not only a short squeeze (the hedge funds were forced to buy back the shares at a higher price) but also a mania that has spread to other stocks.

GameStop’s rise from a pedestrian retailer to a company that is at the time of writing worth $24 bn, continues a market theme of the past year where assets (Tesla, bitcoin etc) diverge wildly from their intrinsic value (e.g. Merrill Lynch has a price target of $10 for GameStop), and where for the first time in a very long period, retail investors (or at least stocks held by retail investors) outperform the market and the institutional community.

As one might expect, Wall Street is not happy. The financial press is full of stories about how the ‘little guys’ are beating the billionaires, and of how the triumph of the Reddit crowd is redolent of the political climate in the US. The decision of some trading platforms to stop trading in names favoured by the Reddit crowd has only increased the sense of ire.

To a very large extent, this has been coming. The arrival of zero fee trading, the development of new trading platforms like Robinhood (who by the way sell order flow data to large hedge funds), financial ammunition (free stocks from trading platforms, plus stimulus checks) and the harnessing of crowds through social media have ‘democratisied’ finance, to put it provocatively. In particular retail trading of options has exploded. Notably, Europe doesn’t enjoy many of these factors, including an ‘equity culture’, so it hasn’t seen the same trading boom (a European stock, Nokia, was picked up US traders).

Without repeating arguments made here previously, the financial climate that central banks have created is also a major factor (market liquidity conditions are the most plentiful in decades), both in terms of their portfolio effect, and impact on risk taking. There is also a sense that central banks are on the side of institutional investors, something that private briefings by the ECB’s chief economist to investment banks last year only reinforces.

For the moment I am less concerned with the way the GameStop phenomenon is being portrayed as a struggle between financial insiders and outsiders, but rather more taken by its implications for finance and for regulators.

This kind of development, together with many others (i.e., ETF’s and cryptocurrencies) should begin to erode the primacy of asset and wealth management firms, a vast number of whom use technology platforms, investment processes and business models that have changed little in the last ten years. There should be greater, downward fee pressure on fund managers who underperform, investment processes should be more centered around liquidity and risk appetite (as well as better encompassing data from options markets and order flow) and in time we should see a wider range of assets introduced into portfolios.  

Two other trends may take off. The first is that the banking/asset management industry should give up on trying to run its own technology projects and instead partner with technology firms. Equally, fintech companies increasingly need the help of banking specialists in order to better understand banking processes, regulation and governance.

The second is that ideally, the notion of the ‘democratization of finance’ takes off so that financial institutions become better at meeting the financial needs of specific groups – from millennials to women for instance.

GameStop’s wild run higher is also a challenge to regulators. It is fair to say that in recent years regulators in the US have done apparently little to regulate manifest oddities in the equity futures market, in the trading behaviour of congressmen and women (Nancy Pelosi trades call options on Tesla!) and the way large investors (and companies) have used the options market to drive equity and debt prices. To that end they should ask what is at stake in regulating the behaviour of retail investors.

The key question regulators must ask is ‘what harm is done’. When speculative behaviour spills over into the real world (for instance causing ‘going concern companies’ to go bankrupt) it must be checked. GameStop itself might react and issues more shares to the retail investors – some of whom in coming weeks will lose, as well as gain a lot of money.

There is likely a temptation on the part of the new Biden administration to strike a more responsible and moral chord regarding Wall Street. It may start with GameStop’s day traders but to be consistent it would have to radically reform Wall Street, which I think unlikely. Instead, we will likely see a cooling of margin trading, and adjustments to the structure of the options market.

The final thought goes to the retail traders. If they wanted to strike out at Wall Street, they might try to target the volatility market (read Robert Harris’ The Fear Index), or more ambitiously if they really wanted to take on short sellers the asset with perhaps the biggest nominal short positions is the dollar. The dollar might spike, and the rest as they say, would be history!

Have a great week ahead,


Poetry in Motion

The Hill we Climb

This time last year I wrote a note entitled ‘Peak Trump, Peak Markets’. For a while during last March, I thought I had nailed the market forecast, but in the end, I got the important part of the equation right, and on January 21 Donald Trump played a lonely game of golf as the Biden administration got underway.

At the present time I am tempted to say that we are in a ‘Peak Markets, Biden Nadir’ moment. That is not a reflection on the abilities of the new President but simply an assessment of the task ahead of him. In that respect two aspects of his inauguration ceremony struck me.

The first was a segment that the three former two-term Presidents (Clinton, Bush and Obama) recorded for NBC, as a message of support for Joe Biden. What was striking was how tired and troubled the three leaders looked, something that attests to the physicality of politics, and also betrays the ways America has been stress tested by the Trump presidency.

The second, more uplifting aspect of the inauguration was the importance of poetry, first in Amanda Gorman’s recital of ‘The Hill we Climb’, and then in Lin Manuel Miranda’s rendition of Seamus Heaney’s ‘The Cure at Troy’. Heaney is a favourite of the President’s, though for poetry that resonates with great historic events he might also try Yeats’ ‘1916’.

While poetry has featured at presidential inaugurations going back to JFK (Bill Clinton choose Maya Angelou in 1993 and Barack Obama choose Richard Blanco in 2013), and Kennedy’s own inauguration speech is acclaimed as one of the best in recent times, the prominence of poetry at last Wednesday’s ceremony marked a potentially notable shift in tone and method.

At a time when Twitter is fading as a political tool (its share price is down 15% since it suspended Donald Trump’s account) there is a temptation to think that short, nasty and brutish messaging is a thing of the past, and that contemplative clever, eloquence is on the way back. Every schoolboy/girl has learnt that Wordsworth described poetry as ‘emotion recollected in tranquility’ and should politics follow this tack, many of us would be happier.

While a change in the tone of political debate, aided by media and social media companies would be welcome, the danger for the Biden team is that they are too erudite, too polite (‘They speak French’, November 29) and to that end fail to get their message across in a very simple way.

As a reminder of what they face, return to Donald Trump’s inauguration speech. It is considered one of the poorest on record, though he did speak prophetically of ‘American carnage’. He also spoke of ‘Mothers and children trapped in poverty in our inner cities, rusted out factories scattered like tombstones across the landscape of our nation, an education system flush with cash but which leaves our young and beautiful students deprived of all knowledge’ but then did everything he could to aggravate these problems.

In that respect, the Biden administration has a clear task ahead – to reduce record inequality, indebtedness, a sharp drop in human development and ailing infrastructure (with the exception of Denver, America has built no new airports in the past twenty five years).

Biden also faces a stock market that trades at some valuation measures seen only in the 1930’s and late 1990’s, with many sentiment indicators also stretched to the upside. Unlike Trump, Joe Biden will not spend his waking hours tweeting about the stock market, and in general I suspect he will not care much for its gyrations. That should leave the road open to some very bold redistributive fiscal policies, which at the same time may not be to the liking of the stock market.

Whether, in six month’s time we are writing about ‘Peak Biden, Stock Market Bottom’ will depend on Biden’s Treasury Secretary. As Chair of the Federal Reserve she at times let market volatility cow her. At the same time, she has the intellectual background and the motivation to do to inequality what Paul Volker did for inflation. A great, and maybe poetic test of nerve awaits markets and Washington. In coming days we may see more restrictive policies on travel and mobility and the forthcoming debate on the stimulus program will reveal much.

Have a great weeks ahead,