Blain’s Morning Porridge – June 1st 2020 – The Disconnect Widens
“Lemon tree very pretty and lemon flower is sweet. But the fruit of the poor lemon is impossible to eat.”
What have we got to look forward to this week?
Around the globe the virus numbers suggest we’re past the moment of greatest danger, but the US riots could well prove a prove a drag on markets and confidence. As I predicted on Friday, Trump’s much anticipated China-bashing speech on Friday proved another lacklustre nothing – providing markets another reason for markets to rally.
But the degree to which soaring markets are diverging from the real economic virus damage, and now rising rage, has become embarrassingly obscene. How can markets set themselves up for new record highs, when hundreds of millions around the globe have been sacked or furloughed and are likely to become long-term unemployment statistics? (Rhetorical question..)
I suspect these riots may be the harbingers of a long-hot summer of discontent – and not just in the US.
To get you started this week, I’m going to recommend a book I have, unfortunately, only half-read. My chums Mark Blyth (a fellow Scot and now rather successful Economist at Brown University) and Eric Lonergan (a fund manager) have just published ANGRYNOMICS. (The copy they gave me to review got left half-finished in the office when lockdown was announced!) The link takes you to the review in the FT.
I’ve been trying to figure out what’s going on and how the current market instability plays out: a dismal outlook and soaring prices. Its complex, but the fact governments and central banks have been able to support markets, bailout businesses and pay salaries has helped with smoothing the initial economic shock. But are all their actions simply creating a deeper delayed crisis? (The answer is yes, and they need to act to avoid it.)
A number of commentators point to burgeoning debt levels around the globe as the metastasising cancer threatening to consume the global economy. I would certainly agree unsustainable debt will prove terminally toxic for many over-levered corporates – and they will need long-term bailouts and support to survive. That is going to fundamentally change the relationship between state and commerce, and we need to figure out how to avoid the private sector simply becoming state ministry of production bureaucracies.
I am also concerned about the increasing risk of sovereign crisis – especially outside the most developed nations, and how defaults across producer/resource nations could create massive, chronic and ongoing instability and potential conflict as nations go bust, triggering supply chain fractures and openings where the Chinese and the West will aggressively compete to seize resource access.
Nations that have borrowed in currencies they don’t own are the most vulnerable – from Argentina to Italy. (Yep.. every Euro member is in trouble..)
But stable sovereigns with stable currencies that can print their own money don’t go bust. They can print money. QE makes it easy. It’s supposed to work by central banks buying debt assets from banks, and the banks then reinvesting that cash into the real economy to fuel growth, jobs, and asset investment.
BUT: As we’ve seen very clearly since 2010 – it doesn’t work that way. Most money created in the financial asset ecosystem by QE remains invested in financial assets.
That’s why QE never created inflation in the real economy. It created massive inflation in financial assets: despite relatively unimpressive growth though the last decade, stocks hit record levels and bond yields fell to record, even negative, rates. That was massive financial asset inflation, and the payback was ever declining yields, forcing investors to assume more and more risk in the search for yield.
QE has become an inescapable trap. The taper tantrum a few years ago when the Fed cautiously tried to start normalisation triggered immediate market instability. It could have precipitated a deeper crisis than 2008 if the Fed had kept going. A market crash would not only trigger recession, but a pensions crisis as thousands of savers saw their futures vanish, and a confidence meltdown.
These are the known long-term consequences of QE and ultralow rates. We now have a global financial system absolutely addicted to it. How do you wean the system off the crack cocaine of QE and ZIRP, without cold turkey destroying the global economy?
One way may be through the magic of Modern Monetary Theory. The way QE works is for a National Treasury to sell bonds in the morning, the government to spend the money by lunchtime, and the Central Bank to buy the bonds in the evening. The result is a liability on the Treasury and an asset on the books of the Central Bank. Quick tap of the MMT wand and the two cancel each other out. The money spent by government remains in circulation. Magic.
Sure, it sounds like madness… but does it matter if central banks show theoretical trillion-dollar losses?
At present, all that money the banks got from central banks for their bonds is immediately invested in more financial assets. We need mechanisms to ensure it’s directed into the real economy – which should be happening through this crisis… but is it? It may be time for Central Banks to start discouraging financial asset investment… Cutting prices by raising bond yields? Transaction taxes?
Shock? Horror! How could anyone be so stupid as to interfere with the functioning of markets. Oh, come on..! QE distortions have seen the invisible hand of markets locked in the deepest darkest dungeon of Chateau d’If these last 10-years. I’m as keen as anyone to see it escape…
Perhaps the only way out of this trap is something very radical? Cancel sovereign debt, create trillions for the IMF to bail out troubled economies, keep interest rates low, and for central banks to buy equity to sustain struggling firms…? (If they do it well, they might even make money..)
How deep do our imaginations go… ?
We could always pay for everything by just properly taxing the rich? Why not?
The summers are getting warmer and the weekends are getting madder. Here on the South Coast of England our village was rammed with tourists who clearly think Lockdown is done. (Fair enough – as we learnt from the Andrew Marr show on Sunday, a Chinese survey of thousands of infections found only one case of the virus spreading in the open air!)
Everyone seems to have spent their furlough money buying paddleboards and blow-up canoes – the river was chock-a-block with people, busier than I’ve ever seen it. It was scary trying to manoeuvre the yacht into our mooring past some of the more oblivious ones – I might have got a bit shouty at a couple. (I was advised not to paint little black silhouette paddle boarders on the bow like the black crosses arranged in rows underneath a Spitfire’s cockpit canopy.)
Madness and fury seems to be consuming the US. Space X launching a rocket to the space station was the light comedic distraction as cities in 30 states experienced riots. I’d never heard of “Antifa” till this weekend, but I guess that mean’s I’m probably banned from the states having gone to a Rock Against Racism festival in 1978, and sporting an Anti-Nazi League badge on my bomber jacket! (As were Jo Strummer and Eric Clapton!)
If being opposed to Fascism is going to be a terrorist offence in the States, but assault gun totting thugs breaking lockdown rules are patriots, then I probably don’t want to be going back to America anyway. Constitutionally, I would have thought it perfectly permissible to be anti-fascist? But, Trump writes the rules.. He’s not supposed to, but who’s stopping him?
I am slightly concerned about the States. When I was young, being brought up on a diet of cowboy films, John Wayne, Star Trek, The Beachboys, The Eagles, and the rest… America was rich, weathly, free and immeasurably more attractive than strife-riven three-day week UK. The American dream looked very real.
Over the last four years, it’s become tarnished very quickly. I can’t help but worry…
Who to blame? Trump… Hell, no.. He’s the product of the times. If anyone can sort it, it’s the Republicans.. If they really want to Make America Great Again, they need to start from the top. (And I can just see the comments rolling in on that one… let me guess.. “lickspittle running dog of the Soros/Rothschild axis…” or some such nonsense..)
Five things to Read This Morning
FT – US market rally masks pain for most stocks
WSJ – Democrats Stick With Tax-Rise Policies as They Make Plans for 2021 Majority
WSJ – This ETF Booms as Investors Bet on Airlines
Bberg – Goldman Rolls Back its Pessimistic Outlook for American Stocks
Bberg – Rebound Gathers Pace for Emerging Markets
Out of time, and back to the day job..