Seriously Stimulating

What would Keynes think?

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

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

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

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

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

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

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

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

There are a few principles to think of.

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

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

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

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

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

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

Have a great week ahead,


Faultlines in a fracturing world

Cracks appear in the world order Source: Esquire

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

This came to mind last week as I was summing up some of the important geopolitical and economic catalysts for my first column as a contributor to Forbes, where the aim is that I write on events outside the USA for a largely USA centric audience (

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

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

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

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

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

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

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

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

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

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

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

September promises to be lively.

With best wishes,


All consequences are at your risk

Lasers battle cameras in Hong Kong

The Chinese military garrison in Hong Kong released a video under the banner ‘All consequences are at your risk’. This an excellent dictum, though only when applied to the behavior of investors, banks and central banks in financial markets. Readers of The Levelling will know that I think the consequences of risk taking across markets are badly distorted, and risk taking and risk baring are mis-aligned.

The dictum might also be applied to President Trump’s twitter account, whose latest salvo has been to up the ante in the trade war between China and the USA after a very lukewarm meeting between US and Chinese officials in Beijing. China, which has been relatively restrained during the trade war will now respond, potentially with a boycott of certain US goods. US tech and capital goods companies look vulnerable.

Then, I should say emphatically that the ‘consequences/risk’ dictum should not apply to largely peaceful crowds in Hong Kong who protest in favour of democracy and an open society of sorts. China, for its part in the domains of economics and technology, has shown an ability to learn from both history and other countries. It should also do so with regard to the situation in Hong Kong and resist the urge to adopt a heavy handed approach.

While the backdrop of the trade dispute helps to paint events in Hong Kong as a context between China and the West, this is not the case, my sense is that the protesters are more standing up for their preferred ‘system’ than against China. A more violent response will change all this.

One of many reasons I drawn to the case of the Hong Kong protesters is the parallels with Levellers. The Levellers were generally constructive in their approach and experts at pamphleteering (the social media of the day). Similarly, the Hong Kong protesters have a (rather short-term) list of demands and are also particularly resourceful, deploying lasers against facial recognition cameras.  The second reason is that the Levellers failed in their project, as many other idealistic, reform minded movements have. Recall the brutal way the Arab Spring was suppressed. The Hong Kong movement need to study the history of other groups, and guard against being outmaneuvered.

One trigger that may upset the balance of power is the scope for damage to the Hong Kong economy, property market and financial sector, and any contagion they may hold for international markets.

A transformation of the protests into a deeper conflict would have grave humanitarian and political implications, and I am simply reflecting my own expertise in focusing on the economic consequences here.

First, the Hong Kong stock market is the fifth largest in the world, heavily dependent on financial and property stocks, and a crucial gateway for Chinese companies that want to access liquid markets and international investors. A sell-off would be contagious via an unwind of investor positioning, the unwind of investment products and heightened credit risk across Asia.

Secondly, the Hong Kong property market, one of the pillars of the local economy, is one of the most precarious in the world in terms of valuation. A house price to income ratio of 18 times is eye watering in a market where the purchase of property is funded by relatively large cash deposits. Also, the property market is heavily financialized in terms of the number of funds and investment products that are tied to it.

The third risk is the Hong Kong dollar peg. In recent months the Hong Kong Monetary Authority has been spending more of its large reserves in supporting the peg. A stronger dollar, combined with lower local interest rates in Hong Kong has put upward pressure on the peg.

Well-established currency pegs are very hard to break, but any signs that the HK peg is pushing its lower limits in the context of a weaker local economy will at least fuel speculation about the peg. This in turn can lead to negative feedback on the local economy and property market, and by extension may also see investors worry more about the yuan. When the yuan weakens, international markets go ‘risk-off’.

There is now an unfortunate ‘perfect storm’ of factors gathering – stronger dollar, deeper trade dispute, acute tension on the streets of Hong Kong. For the sake of people in Hong Kong I hope it doesn’t worsen, though if it does expect contagion to spread quickly to financial markets.

Have a great week ahead,