Dazed and confused (or at least a bit surprised and disappointed)
This is the conclusion to the recent article, Crises, what crises?[1]
Lately, we’ve been finding ourselves surprised.
And sometimes disappointed.
Especially by policymakers.
Policymakers whose geopolitical brinkmanship leaves us closer to an existence level threat than ever before.
Policymakers whose economic ineptitude drives us ever closer to financial disaster.[2]
Ultimately, we’re disappointed that the most important global economy is hamstrung by a system that throws up wholly ineffective politicians producing totally unsuitable policies within a framework that works to the detriment of most Americans.
As we recently fulminated,[3] the debt-ceiling fiasco[4] is a nonsense process, just like most American so-called law-making. For most Americans, success is achieved despite a socio-legal framework that adheres, by design, to narrow interests because of an anachronistic set of rules. Until it is acknowledged and redressed that America’s constitution is no longer fit for purpose (which is unlikely any time soon) the system will keep yielding unsatisfactory outcomes and unacceptable candidates such as the late John McCain, Hillary Clinton, Donald Trump and Joe Biden, none of whom have ever been fit to run a bath, much less a country. All of whom, with the possible exception of Trump who hasn’t yet figured how to turn it to personal profit, seem determined to lead us into nuclear conflict.
The latest round of debt ceiling elephantine pas de deux is temporarily over but at huge cost to the US economy.
“The deal crafted by President Joe Biden and House Speaker Kevin McCarthy….avoids the worst-case scenario of a payments default triggering financial collapse. But it also could, even if at the margin, add to risks of a downturn in the world’s largest economy.
Federal spending in recent quarters has helped support US growth in the face of headwinds including a slump in residential construction, and the debt-limit deal is likely to at least damp that impetus. Two weeks before the debt-limit deal, economists had calculated the chance of a recession in the coming year at 65%, a Bloomberg survey[5] showed.”[6]
Let’s just remember how we got here – competition between nations resulted in the wars of the 20th century. The re-ordered post WW2 world saw a new order with America at the centre of global trade and finance. Building this new order resulted in decades of global economic growth, wealth creation and capital market expansion, with America at its core, as the main beneficiary. This resulted in a build-up of debt, which at various times appeared unsustainable within the existing rules of the system. Rather than accept these synthetic systemic limits to growth, policymakers, with some justification, reacted by changing the rules.
Nixon closing the gold window in 1971, removed the artificial constraint on sovereign money creation – an effect that was to become pronounced over time:
In the hands of those who hold the reins of American power, this extrpower has however, generally been used not for good, but if not for outright evil, then something negative and divisive -the benefit of the US financial system. The explosion of government ‘debt’ has underwritten the expansion of US capital markets, as we can see from charting the size of US equity markets following the removal of the gold standard chains:
This doesn’t mean that Nixon was wrong to close the gold window. Many of the material and technological benefits that we all enjoy today would have taken far longer to achieve in a capital constrained world. But it does mean that we shouldn’t have entrusted to politicians the stewardship of creating the best part of an additional $40 trillion in interest bearing (what we mistakenly call US national debt) and non-interest bearing (what we typically call currency). Instead of investing that productively in education, or healthcare or housing or infrastructure or welfare, policymakers have largely used this to underwrite the financial markets.
Of course, this wasn’t solely down to the increase in government ‘debt securities’ or treasuries (which we should just think of as interest-bearing currency), it also spawned liberalisation of bond markets, with the growth in corporate bond markets, high yield bonds and derivatives, all of which grew at much faster rates than the underlying economy, thereby further shifting the relative balance of economic power from main Street to Wall Street-
“Since the 1970s, the rapid expansion and globalization of financial markets shadows most other recent developments in international economics.” - Prof. Roy E Allen[7]
Ultimately sovereign money creation, bond market intermediation, ever-growing capital markets fuelled capital markets far more than they financed the commercial economy:
Like the insatiable bloodthirsty Audrey in Little Shop of Horrors, capital markets need constant inflows for prices to continue to ratchet higher, meaning that capital markets require an ever-greater volume of money creation to continue their rate of ascent.
The changes that were made to accommodate this ever-growing need for capital has resulted in consequences for various parts of the markets from the S&L crisis of the 1980s-90s, to the tech wreck of Y2K, to the sub-prime lending bust and Global Financial Crisis (GFC) of 2007-9. The reaction to the GFC was the starkest yet. The need for immediate responses to support the financial system led to zero interest rate policies (ZIRP) and asset buying programmes, such as quantitative easing (QE) that enabled policymakers to fund the banking and financial sectors much more directly. The scale and self-evidently circular nature of this response have at times led policymakers at institutions (e.g. the Fed) to question the sustainability and purpose of-uninhibited increases in money creation to fuel capital markets and financial sector expansion. Elected lawmakers haven’t generally exhibited such qualms.
Attempts by the Fed and/or Treasury to ‘normalise’[8] monetary and fiscal policy led to economic and capital market headwinds in 2015 and the repo crisis of 2019, that in both cases saw policymakers reverse their attempts at ‘normalisation’ even more aggressively[9]. At the beginning of 2020, the US Fed and Treasury seemed determined to increase interest rates and to start selling, rather than buying, financial assets.
When the pandemic arrived, they pretty quickly gave up and embarked on the most widespread and aggressive asset purchase programmes, including providing funding to US corporations, while also directly issuing payments to individuals. Like many government policies, this was a potentially good idea…..that was badly implemented and misunderstood by policymakers. This bungled implementation directly contributed to the supply shock inflation that has turned economies and markets and investment markets into a roller coaster at various times since 2020.
The debt ceiling Kabuki farce was the latest iteration of this, with policymakers on both sides demonstrating the exponential growth of self-importance and ignorance that comes from the global, and in this instance American, mechanism for giving the least suitable people (such as Donald Trump but above all Joe Biden) the keys to power.
The debt ceiling impasse looks like it has been temporarily ‘resolved’ Once this was announced, we indicated that we expected risk assets and risk currencies to rally in relief. At least until it becomes apparent that this latest resolution to the current iteration of this archaic contrived constraint to growth and to functioning economic policy looks likely to achieve a compromise that will hurt America’s future very badly. The argument that having such a constraint stops policymakers spending money in destructive ways might seem attractive but sadly, it’s wrong. Policymakers prioritise stupid ways of spending money – anything smart or productive tends to be the final element of discretionary spending. Tie policymakers in knots like the debt ceiling and you simply get the same level of stupid but pure and undistilled stupid, in ways that will damage the American economy. At some point, when the damage to families, jobs and businesses (probably in that order) becomes intolerable, policymakers will, to misquote what is often falsely attributed to Churchill, do the right thing only when all other possibilities have been exhausted. Often the damage inflicted by this stage is severe and on an individual level irreparable.
So, we’re disappointed that the debt ceiling involves policymakers (in this case American) once again shooting the people they’re supposed to represent in both feet but we’re not that surprised.
For now, the short-term prospects for risk-assets look supportive but highly fragile – we don’t know how long these will continue. The prospects for assets that imply weaker growth and lower interest rates look very attractive in the medium to longer term but remain challenging in the shorter term. Balancing the trade-off between what seems to be working but has deep and wide structural flaws, and what is soundly built but out of favour remains a challenge. As always, we’ll continue to try to walk the high wire without falling off.
[1] https://mbmg.substack.com/p/crises-what-crises
[2] As Senator Warren recently pointed out, the Fed are relying on policy approaches that have worked on zero occasions, the last dozen or so times that they were tried.
[3] https://mbmg.substack.com/p/crises-what-crises
[4] The debt ceiling reminds us of the seemingly interminable Friday 13th franchise of horror films – surely nobody can be shocked anymore when the scary music starts to play?
[5] https://www.bloomberg.com/news/articles/2023-05-19/cooler-us-economy-seen-transitioning-to-second-half-downturn
[6] https://news.bloomberglaw.com/private-equity/debt-deal-to-hit-a-us-economy-already-facing-recession-risk-1
[7] https://www.elgaronline.com/display/9781785361104/chapter01.xhtml
[8] We don’t know what that’s supposed to mean either
[9] Although we don’t know of any public official admitting that they were reverting to abnormalisation
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About the Author:
Paul Gambles is licensed by the SEC as both a Securities Fundamental Investment Analyst and an Investment planner.
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