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,


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.