Heroes; Events, dear boy, events…

 

 

‘There must be some kind of way outta here 

Said the joker to the thief’ 

 

Firstly, apologies for the lack of articles last week, we took the opportunity to enjoy some late summer sunshine! 

Now, refreshed, we turn to matters more pressing.  

The situation in Palestine and the Gaza becomes daily more of a concern. Not just the humanitarian issues, but the geopolitical questions the conflict throws up. 

Look back almost 50-yrs  ago a surprise attack on Israel by neighbouring countries marked the start of the Yom Kippur war. Whilst it wasn’t obvious at the time this signalled the end of the long postwar boom and began a period of  higher inflation and rising unemployment. 

Last week, finance ministers, development ministers and central bank governors from around the world were gathered in Marrakech for the annual meetings of the International Monetary Fund (IMF) and the World Bank. 

The IMF, whilst still hoping for a soft landing as economies deal with sharpest rise in interest rates in decades, is also recommending that rates stay higher for longer, believing that asset prices will remain resilient. 

This sounds like wishful thinking, or, perhaps, complacency. As Michael Jacobs, a fellow at the Overseas Development Institute thinktank said, ‘The bar for the meetings was set low, and they only just cleared it.’ 

More prescient might be the warning from Jamie Dimon, the CEO JP Morgan; ‘this may be the most dangerous time the world has seen in decades‘. 
 

‘this may be the most dangerous time the world has seen in decades‘

 
Dimon clearly sees the signs, a war in the Middle East could reverse the recent fall in inflation, prompting central banks to increase interest rates, leading to a sell-off in the financial markets. 

If that was to happen, then it would exacerbate the current situation; last month’s trade and development report from the UN Conference on Trade and Development said that high interest rates were already causing rising inequality and lower investment. 

The world has just experienced its hottest September on record, the war in Ukraine shows no sign of ending, the pandemic and its aftermath have led to the first increase in the number of people living in poverty in decades, and the willingness of countries to cooperate to solve problems is at a low ebb. 

In addition to the fragile state of global economies, there is the ongoing issue highlighted 10-yrs ago by Paul Krugman, the Nobel prize-winning economist, that politicians, predominantly right–wing,  argued that unless governments cut their deficits, ‘bond vigilantes’ would pressurise them by forcing up interest rates. But if they did cut them, the story went, then the ‘confidence fairy‘ would magically stimulate so much private spending that this would compensate for the loss caused by budget cuts.  

In truth, the so-called bond vigilantes are often just hard-right politicians, arguing debt levels need to be cut to support their own political agenda of smothering ‘left wing’ efforts to spend nations out recession via welfare, housing or infrastructure initiatives, and green transitions. 
 

‘the willingness of countries to cooperate to solve problems is at a low ebb’

 
History proves Krugman right; austerity didn’t produce economic growth, and, like all fairies, the confidence fairy is a myth. Despite this cold, hard reality, politicians continue to believe it. Every major UK political party wants more economic growth, and to do that the deficit must be cut. In March the OBR, in a moment of wild optimism, forecast March that the UK economy would grow by about 2%. The IMF forecasts a somewhat more realistic two years of about 0.5% growth.  

I wrote of Truss before she was elected as Tory leader that she was dangerous and deluded, her continual belief that cuts will lead growth is only more proof that I was right. 

Higher interest rates have also resurrected old fears about western nations’ public debt, and the idea that they are determined solely by ‘market forces’. Bond vigilantes(1) don’t exist. When pension funds started dumping UK bonds after the Truss/Kwarteng fiasco budget, it was about competence; their fears that the government was incompetent. 
 

‘after the Truss/Kwarteng fiasco budget, it was about competence; their fears that the government was incompetent’

 
On Friday Jeremy Hunt, the chancellor, said ‘difficult decisions’ lie ahead on the public finances. He was looking at the recent sell-off in government bonds and the rise in yields, leading to higher debt service costs. Central banks won’t let governments default in their own currency, but they appear to support the myth that fiscal extravagance makes a bond-market attack on heavily indebted governments likely. The end result is obvious; the poor suffer from yet more spending cuts. 

Until Thatcher and Reagan, the postwar consensus was that economic growth was secured through the fiscal stimulus of an enlarged budget deficit and quiescent rate policy, while regulation and price controls kept inflation in check. Thatcherism argued that the reverse was true: growth would be obtained by doing away with government regulations, and inflation brought down by cutting the budget deficit and aggressive rate hikes.  

Free-market economics died on the bonfire of free-market, the GFC, which saw governments pumping trillions into the world economy to save it. 

Yes, rising bond yields / interest rates have painful economic consequences for consumption and production as economies adapt after decades of artificially low rates. 

But, rising rates do not spell the end of the world. 

In truth, the increase in interest rates are long overdue; they reintroduce a degree of common sense and financial sanity to the allocation of resources, which will should invigorate growth by refocusing investment from financial assets into real economic growth. 

Todays ‘normalised rates’ are returning us back into the historical 5% range. As a result corporates might begin to act responsibly, I.E., taking measured investment decisions rather than simply ramping their own shares vis stock buy backs. In turn, all of this will burst the speculative bubble created by the absolute low level of distorted rates. 

I mentioned earlier competence, which in the words of one writer is part of Virtuous Sovereign Trinity; a stable currency and sustainable bond markets, held together by competent politics. 

The long-term problem western governments face how to rejuvenate tired economies: repair and replace failing infrastructure and utilities, address inadequate social services, overcoming rising inequality, whilst managing the transition to cleaner, more reliable renewable energy sources, all the while fostering growth to maintain and raise living standards. These all require large scale investment  

The economic theory of Reinhard and Rogoff was that based on rising debt inevitably causing weaker growth. They suggesting that at > 80% debt/GDP government debt crowds out other financing and growth and slows the economy, thus austerity spending and limited government borrowing is a good thing. 
 

‘talk of imminent debt catastrophe across the West, and the fastest pace of interest rates rises in history’

 
Perhaps the assumptions that debt is bad is missing an opportunity for the reconstruction of economies. Markets set prices, and the government bond market has proven efficient at pricing risk. 

There has been talk of imminent debt catastrophe across the West, and the fastest pace of interest rates rises in history, yet there are no signs of real stress in bond markets. What has happened is that yields have risen and prices fallen in response to central banks fighting inflation, which is exactly what should happen in efficient markets. 

The underlying principles of bond markets are simple, investors care about: 
 

• Being paid interest when due 
• Receiving back principal. 
• They watch inflation, in order that during periods of inflation their returns remain positive. 

 
They also understand the basic rule of Sovereign debt: no country with its’ own sovereign currency will ever, ever go bust or default. A nation can issue debt and pay interest and principal by printing money. 

This is the fundamental problem with the Euro; members can’t avoid default by printing more Euros, they need a consensus among the ECB states to do so, As we saw, German workers didn’t want to be paying Greeks pensions. 

The US has outstanding debt of $33 trillion ($27 bln of Treasures and $6 bln of inter-government debt), but could repay it all by simply printing money. Yes, this isn’t the best scenario but it’s a lever they can pull. 

Countries that default on their debt inevitably do so because they borrowed (unhedged) in another currency, and when the time comes to repay that debt, they have to buy back that currency on the open market or via central banks because some other country owns the keys to the printing press.  

The key is understanding the parameters of what debt might do to the currency, inflation and the economy. For example, post-GFC zero interest rates and QE generated massive hidden financial asset inflation which in turn financialised the behaviour of participants in the real economy. 

Therefore, debt should not be a problem for a nation that maintains a Virtuous Sovereign Trinity of a stable currency, a sustainable bond market, and political competency.  
 

‘debt should not be a problem for a nation that maintains a Virtuous Sovereign Trinity of a stable currency, a sustainable bond market, and political competency’

 
The markets act as ‘safety-valves as Truss found out. When governments borrow markets price demand vs supply, as a result rates rise when governments borrow too much. It isn’t unusual for governments to borrow more than they raise from tax, provided that the size of the government debt remains about constant to the size of the economy. For example, Japan has a 300% debt to GDP ratio. 

Thatcherism was based on the tenet that it should not be the business of government to finance the economy. Her solution was privatisation. This has been shown to be a catastrophic failure; private ownership has left public utilities arguably worse than before when they were publicly owned. The only beneficiaries have been the owners who have priorities unreasonably high dividends. All that has happened is that inequality has got worse. 

Turning specifically to the UK, it looks increasingly likely that Labour will form the next government. 

During last week Labour party conference the party was keen to demonstrate economic credibility. Shadow chancellor, Rachel Reeves, professed to be the iron chancellor who gets UK economy back on track 

Stephen Phipson, the chief executive of the manufacturing trade group Make UK said; ‘What we’ve seen from the Labour party is a really strong commitment to making things in this country. We never saw that last week at the Tory conference. The whole thing about stability – it was perfect. We have been calling for this for years.’ 

The key takeaways were: 
 

• Labour is open for business 
• They are opposed to tax increases 
• They favour spending discipline, financing day-to-day spending through tax receipts, get debt down as a share of the economy, and then, ‘subject to that, invest in things that boost the potential of the economy‘ 

• Business investment is a priority; Labour plans an £8bn ‘national wealth fund’ designed to coinvest public money alongside the private sector, with a focus on renewable energy and new technologies. Reeves said that for every £1 of public money spent, Labour wanted £3 from the private sector to ensure the state gets ‘bang for your buck‘. 
• Starmer wants to build, not block. However, Labour failed to offer any commitment to reinstate HS2 Birmingham to Manchester, using Sunak’s decision to highlight the government’s inability to build large infrastructure projects 

 
Safe policies, probably. Underwhelming, totally. What will they change? Nothing. 

It feels like they are trying to appeal to everyone, and possibly appealing to no one. It smacks of a party so desperate to attain power that it has lost its way. 

Labour was based on the redistribution of wealth; voters, such as the ‘red wall’ deserted them because income inequality was out-of-control, and Johnson lied about levelling-up. There is nothing in these aims that deliver any form of levelling-up. 
 

‘It smacks of a party so desperate to attain power that it has lost its way’

 
What happened to increasing the rate of CGT which is taxed at a lower rate than income?  

A government review commissioned by Sunak in 2020 showed that up to £14bn a year could be raised by increasing the 28% rate charged on capital gains to match rates of income tax (20% for basic-rate taxpayers, and 40% and 45% for higher and additional rate earners in England and Wales). 

Sharon Graham, the general secretary of the Unite trade union, said another option could be to launch an entirely new levy. ‘As a starter, a 1.5% annual tax on wealth over £10m would bring in about £17bn a year. There’s a choice I think most people could get behind.’  

Paul Nowak, the general secretary of the TUC, said an incoming Labour government would inherit a devastating outlook for the public finances from the Conservatives. ‘If you’re serious about rebuilding the NHS, repairing and renewing services … we’re going to have to find the money from somewhere.’ 

 

The irony of Sunak’s position is that the electorate might, in principle be willing to embrace more leftwing ideas but, as Jeremy Corbyn discovered, they have been reluctant to vote for them. Corbyn’s manifesto contained proposals such as free broadband and higher taxes on the wealthy, that were designed to appeal to an electorate fed up with the system. Instead they bought into the snake-oil charm of Johnson. Many speculate that whilst people wanted change they lacked faith in Labour’s ability to achieve it. Of course, the elephant in the room then was still Brexit, and it is hard to quantify how much that impacted peoples choices. 

Perhaps Labour got lucky, as they would have had to deal with the tsunami of Covid-19 and lockdowns, which, in-turn led to recession, a ballooning budget deficit and, as the economy recovered, the highest inflation in 40 years.  

As a result Labour enjoys a 20-point lead in the polls, the election is there’s to lose. In turn, they now have to decide tactics; do they double-down giving the Conservatives little to attack? Or push a  ‘time for a change’ agenda? 

Doubling down runs the risk of being seen as a Tory tribute act, allowing Sunak to argue that only the Conservatives will meet the demand for change. Yet, something more transformative may rekindle concerns about whether Labour can be trusted with the economy. 

The state of the economy should make victory easier for Labour.  
 

‘The state of the economy should make victory easier for Labour’

 
Whilst wage growth will start to run ahead of inflation, it will take time for any modest boost to living standards to be detected by workers. In addition, the BoEs interest rate policy may have tempered inflation but only at a cost; unemployment has started to rise, house prices are falling, money and credit growth is weakening, and there is little chance of either the Treasury or the Bank of England doing anything to counter growing recessionary pressures. Higher government borrowing costs limit Jeremy Hunt’s scope for pre-election tax cuts, while the Bank thinks interest rates need to stay high for some time in order to bring inflation back to its 2% target. 

As Thatcher appreciated bringing about change requires boldness and conviction. Austerity, small government, balanced budgets, and  privatisation are history. All they have ultimately delivered is a country divided into haves and have-nots, public services, including the NHS, no more than survive, and privatisation has delivered worsening services and benefitted only the haves.    

If we don’t embrace change after the economic and social disasters of the last 13-yrs we never will. 
 

‘Look at you fooling you 

The deeper in debt, the harder you bet’ 

 
Notes: 

1. A bond vigilante is a bond market investor who protests against monetary or fiscal policies considered inflationary by selling bonds, thus increasing yields 

 
A very welcome return from Philip, and a pretty stark view of things:

As the party conference season winds down, Labour look to be the clear winners.

Yes, they delivered safety-first proposals, but it never felt like they were getting to grips with the real problems. It was samo, samo, but we aren’t as mad, nasty, or divisive as the Tories.

I was struck by an overwhelming sense of fear, that doing anything different would be rejected by the electorate. After their defeat in 2019 that is understandable, but surely they can see that the Tories are totally discredited, and reduced to factional in-fighting.

In addition, the Tories traditional voter base, the over-65s are now a minority amongst the electorate.

What might not be factored into calculation is what might happen to the Tories between now and the election. There is clearly disquiet amongst their MPs, as was highlighted by 60 joining Truss’s “growth group”.

Nigel Farage is the elephant in the room. If he was to throw his lot in with Reform UK and, or, Truss’s malcontents linked up with him, they would constitute an electoral force.

I would guess that this coalition would find favour in red wall seats, and possibly with a number of over-65s. As such they could win a substantial number of seats, leading to a coalition that would have to contain, and deal with them.

Whilst this all sounds fanciful, the right is in ferment now, seeking ways to cling into power. Farage holds the key; does he stay in the wings acting as a mischief-maker, or seek the ultimate goal?

Whichever way he jumps, his legacy is assured. Brexit will continue to fester away, sacred to those too blinkered to see anything more.

I know there are many who feel that putting the subject back on the table is electoral suicide, but the timing is ideal.

I read with interest that the German finance minister, Christian Lindner, has issued an open invitation to the UK to reach a new deal to improve Brexit trading relations that would reduce trade barriers. He told the BBC: “This is a standing invitation for the UK: if you want to intensify your trade relationship to the EU, call us. We really appreciate the United Kingdom and its values, its people … and I would really, really appreciate it if we can intensify [the trade relationship] again.”

He went on, saying; “In the daily life of German corporates, there are new obstacles since Brexit … I don’t think [the] United Kingdom is benefiting from Brexit.”

Germany is the UK’s second-largest trading partner, according to UK government statistics released in September, accounting for 8% of total UK trade.

At least someone gets it.

Musically we take inspiration from the late 1960s-early 1970s when revolution and change was in the air. We start with the Jimi Hendrix Experience and “All Along the Watchtower”, we finish with the often overlooked Sly and the Family Stone and “Runnin’ Away” from the 1971 album “There’s a Riot Goin’ On”. Enjoy!

@coldwarsteve
 

 

 

Philip Gilbert is a city-based corporate financier, and former investment banker.

Philip is a great believer in meritocracy, and in the belief that if you want something enough you can make it happen. These beliefs were formed in his formative years, of the late 1970s and 80s

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