Friday 13

Lagarde, Merkel

In the current panicked environment, it will not have escaped the attention of most people that last Friday fell on the 13th of the month. Friday 13th is typically seen as an omen of dark things to come, though its origin is more interesting than many will suspect.

Friday 13th October (1307) was the day that King Philip (le Bel) IV of France launched a lightening raid against the Knights Templar, imprisoning their Grand Master Jacques de Molay and many others. Philip was in debt to the Templars, whom he also feared for their military power and the clout of their pan-European financial network (they in many respects, invented banking as we know it).

The Templars were subjected to years of torture, the techniques of which prefigure the worst of the Inquisition and recent wars (i.e. water boarding). At the end of some seven years in captivity, Jacques de Molay was arraigned, and upon declaring that his only mistake was to renounce the Templars, he was carted off to be burnt at the stake (there is a memorial to him at the end of Ile de la Cité in Paris). Before dying, he cursed Philip and the Pope, both of whom died within the year.

While this tale is a good diversion from the ups and downs of the Dow, and to scare you the death of de Molay was followed thirty years later by the bubonic plague, it has made me think of the the link between torture/pain and one’s view of the world.

In de Molay’s day, torture quickly made the Templars recant their views, and in markets the same is true today. My first thought is of ECB President Christine Lagarde, who having been born in Paris should be familiar with the plight of the Templars.

On Thursday she stepped into the fire of markets by declaring that it was not the job of the ECB to close bond spreads. It was a brave statement, delivered at exactly the wrong time. Regular readers will know that I often rail against the ‘morphine’ that central banks have provided to economies and markets, and of the need to curb the oversized role of central banks. Lagarde, wisely I think, agrees and she has also expressed the view that European governments (especially Germany) need to be much more fiscally active.

By choosing to express this near heretical view, Lagarde risked monetary martyrdom, and disarray on the periphery of the European bond markets. I suspect that the pronounced and prolonged market volatility will produce a more generous and less thoughtful policy response from the ECB. We should expect a rate cut, more QE and liquidity intervention and I suspect more joint communiques with the Federal Reserve.

Lagarde is not alone in having her feet held to the fire of the market’s ire, Angela Merkel may be next. If there is a time for Germany to engage its borrowing power and fiscal surplus, it is now. Berlin needs to quickly communicate a plan to stimulate the German and by extension the European economy. This must also include ambitious structural objectives such as the need to a unified pan-European capital market, banking consolidation and a common approach to business start-ups across the EU.

If Merkel doesn’t act now, her career will be marked by banking collapses and rising unemployment. Like the network of the Templars, the future of the Union is at stake.

In the same way, the future of Donald Trump and the American approach to capitalism is also at stake. His administration is not the exemplar of the kind of big, responsive and diligent government that is necessary to defeat this crisis. Neither is big, responsive and diligent government something that can be conjured up in the short-run.

As market pain persists, I suspect that the Trump administration will increasingly turn ‘socialist’, and ask the private sector to take the strain of the coronavirus crisis (i.e. organizing testing, work from home and a less aggressive approach to layoffs), and will push for new monetary measures such as ‘helicopter money’ from the Federal Reserve. As the unfortunate Jacques de Molay found, pain can motivate great inventiveness.

Have a great week ahead,

Mike

Recession rehearsal

Powell under pressure

The last week has seen many different expressions of adaptive behaviour. First, the Democratic Party establishment and organisation have rallied around Joe Biden, and helped to push him to stunning turnaround in the Party’s campaign for President.

Then there has been widespread adaptation to the coronavirus – people have stopped shaking hands, travel only when necessary and it seems, lead incrementally more healthy lives (though a half-marathon I had entered was cancelled). In some cases however, stoicism wins out – the London Tube is as packed as ever.

In markets, investors – a great deal of whom are unsentimental robots – are adapting to extreme volatility. It has been one of the most extraordinary weeks in markets as investors try to position around the uncertainties introduced by the coronavirus. If and when we get it, a mid-twenties reading on the Vix volatility index would suggest that what might be described as ‘normal’ trading is getting underway. 

Then, policy makers have also been adapting, slowly. My sense is that to a large extent the policy reaction to the coronavirus is a rehearsal for how the next recession is met. So far, it has been a shambles. 

Jerome Powell, in making a 50 basis point cut in interest rates revealed that he is beholden to both equity and bond markets, and it seems, to politics. His action underlined the existence of the Fed ‘put’ – that the central bank will ride to the market’s rescue in times of turbulence.

The delivery of the rate cut was poor.  It focused insufficiently on the sense that this move would provide ‘insurance’ and on the ways it might combat the economic panic (e.g. risk of bankruptcies) associated with the coronavirus.

With the idea of a ‘rehearsal’ in mind, Powell’s move contributed to a feeling that when the ‘real’ recession comes, the Fed will have relatively little monetary ammunition and may, like the ECB and Bank of Japan (BoJ), have to resort to extraordinary measures like negative interest rates. 

If that is where the Fed is headed to, then the lesson for them from the likes of the BoJ, ECB and Riksbank in Sweden is not a happy one. The rush towards very low to negative rates in those monetary jurisdictions undercut banking sectors – a key reason why Europe and Japan have had weak recoveries, and also why to date US banks have outcompeted their international rivals. Sharply cutting rates, in tandem with a compressing yield curve, undercuts the balance sheets of banks, and in some cases can deepen a downturn. The Fed needs to study this carefully.

The second issue with the political response to the economic side-effects of the coronavirus crisis so far, is that despite G7 conference call and very general statement of intent, there is little apparent leadership and coordination.

The fracturing of international politics has made sincere collaboration difficult in practice (America might for example have announced a moratorium on sanctions on China). Moreover, the absence of a serious fiscal response in countries like Italy (the support measures announced come to only 0.3% of GDP), and the notable lack of open thinking on how deregulation might serve to boost business, is worrying.

I may be a little too critical here, but the sum of the week’s policy activity highlights depleted economic arsenals. Debt is too high and few countries have a decent fiscal surplus. Those that do, like Germany, don’t have the will to spend it.

It also points to a depleted international policy community – where the goodwill, leadership and force of mind that existed in the 1980’s or 1990’s (I am thinking of the likes of James Baker or Robert Rubin) is no longer visible. In Europe, Christine Lagarde has been strangely quiet.

There is now a need, an opportunity and hopefully time for someone like Kristalina Georgieva, or even departing Bank of England boss Mark Carney, to so a postmortem on the economic policy response to the coronavirus crisis. With world debt to GDP at its highest level since the Second World War, the next recession will be for real.

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

From Rotten Heart to Braveheart?

Boris was wrong!

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Have a great week ahead,

Mike

How to reconnect Europeans with the EU

The EU elections, like the Eurovision song contest is, for some, a chance to poke fun at the EU and at the more colourful characters contesting seats. Turnout will be relatively low, reflecting the fact that for many Europeans, power lies in national assemblies, and also the fact that they do not entirely understand the role and purpose of the EU Parliament.

In this respect the EU Parliamentary elections will do little to bridge the political and emotional gulf between the EU and its citizens. My own experience is that whether I am in the north of Greece, west of France or south of Ireland, Europe’s citizens are losing their sense of what the EU means to them in a tangible way.

The core elements of the project need to be remade, and done so in a way that brings them closer and more meaningful to Europeans. One example is the constitution. One frequently noted rejoinder during debates on the politics of the EU is to ask whether anyone has in fact read the EU constitution. Few have.

The EU constitution is some four hundred pages long (at seventy thousand words, it is seven times as long as the French and Dutch constitutions), and it is unlikely that many Europeans have read it or that they keep a copy close to hand.

Lawyers and academics will tell us that constitutions are legal documents and as such are long and complicated. Still, weighty texts like the European Constitution put distance between people and those who govern over them.

This is one of the ways in which politics today has created a sense of disconnect between insiders and outsiders. From a socio-political point of view, it is a disturbing divide because Europeans are losing confidence in the European Union, and as multiple economic and humanitarian crises take their political toll, Europeans are losing their sense of what Europe stands for.

One proposal, which may go just a small way to repairing the gap between the EU and its citizens, is for Europeans to have a short, tangible and agreed account of what it means to be European.

One thoroughly modern response might be to use artificial intelligence to optimize the constitutions of the various European states and to condense them into one, meaningful page. The algorithm would extract core beliefs and principles from the constitutions of a range of countries and boil them down into a single, short document.

A more straightforward tack would be produce a short document that highlights the meaning and relevance of the European Union for its many citizens. It could be done as follows, and maybe the next Commission might take this up.

The exercise would involve European citizens running pilot projects to discover what they feel they have in common, where they feel they are different, and what policies might, to their advantage, draw them together. To think aloud, an initial pilot project could be based on the participation of a retired Portuguese teacher, a Polish bank clerk, a German policewoman, a Latvian student, an Italian pensioner, and a Swedish nurse.

Their goal is to produce, on a single sheet of paper, the answers to the following questions: What do they, as Europeans, have in common? What can they stress as common values and aspirations, what policies might bring them closer together as Europeans (i.e. the Erasmus pan-European student-exchange program).

The answers might start off with the fact that most Europeans have a common history, one that has been marked by wars, scarred by the rise and fall of empires, shrouded in Christianity, and shaped by the passage of monarchy to democracy and autarchy, the rise of learning and culture, and, from the thirteenth century onward, the evolution of great cities.

This is an altogether broad and historical view of European identity, and it might well permit the inclusion of countries, such as Russia, that are not considered part of Europe today. The sum total of this historic experience might well inspire citizens to say that they have the following common values: peace (not to have another European war), the influence of the Christian church(es), democracy, recognition of the benefits of social democracy, and free movement of EU citizens.

This may just be a starting point, and it might even gain clarity through the participation of the growing number of pan-European couples and their children. Such an exercise may not also produce the unity of views that pro-Europeans may desire, but it will make Europeans think about what defines their region at a time when the US and China are reinforcing their own identities.

The next trick will be to get Europe’s leaders to react to such a template.