2018 Into 2019
Politicians seem increasingly to be pursuing policies that are economically harmful and/or socially divisive.
Dictatorships by definition have no problem with putting their own interests above the welfare of their subject peoples but the fact that democratic politicians are doing so too points to systemic change. Amongst the democracies, which together with China encompass for the overwhelming majority of financial assets, political leaders appear to fall within four broad and overlapping categories:
- Leaders who are deluded
- Leaders who are ignorant
- Leaders who know about the potential harm but feel it is necessary
- Leaders who know about the potential harm but think it might be to their ultimate advantage
I invite readers to judge for themselves various world leaders but would suggest that President Trump falls at different times within each of the four categories. As the New York Times recently put it: “People wanted disruption, but too often Trump has given us destruction, distraction, debasement and sheer ignorance.” It is perfectly legitimate to want to effect change by ‘shaking things up’ but intelligence, consistency and consensus are essential to good democratic government. Mr Trump’s domestic agenda, controversial as it may be, is of less direct consequence for investors than the replacement of NAFTA, withdrawal from TPP, tariffs on imports from China, an explosion in the federal deficit, a government shutdown and undermining Fed independence. Some of his policies may seem sound enough but the chaotic whole represents a major hazard to the US and global economies as well as domestic and international investors. It is quite possible that during 2019 Mr Trump may step down in return for some plea bargains for himself and his family but any departure will surely be messy. Nor is the thought comforting of a President Pence, who already claims to be in regular two-way contact with the Almighty.
Meanwhile in the UK, Sir Ivan Rogers, who was sacked as UK Ambassador to the EU for pointing out the practical challenges of Brexit, has captured the new order: ‘We are dealing with a political generation which has no serious experience of bad times and is frankly cavalier about precipitating events they could not then control, but feel they might exploit.” These remarks are surely applicable to the leaders of both political parties in the UK as well as the Populist parties around Europe as they strive to disrupt historic consensus with ‘Brexit-like’ shocks.
On Brexit itself, I am sticking to my expectation that Mrs May will take the initiative in withdrawing Article 50 Notice after her deal is heavily defeated in the Commons and without calling a divisive general election or second referendum. The veteran Ken Clarke this week advocated this course to give more time for the proper preparations that Sir Ivan (and others) have consistently advocated. As an ‘irredentist’ Europhile, Mr Clarke may be verging on the disingenuous as the legitimacy of the 2016 referendum is steadily diminishing with the passage of time. Mrs May will, no doubt, be reluctant to abandon her self-proclaimed legacy but avoiding a referendum would help keep together the party that she so clearly puts before herself (and the country). Mr Corbyn would also like to avoid a referendum as this would allow him to conserve the ideological purity that he seems to value more than bending to the wishes of his MPs and their voters (and the country). It remains extraordinary that the leaders of both main parties wish to pursue a Brexit that would inflict so much damage on the economy at large and on the welfare of the most vulnerable in society. Crunch time is nearly upon us, which is just as well with the official preparations for a ‘no deal’ Brexit becoming more and more outrageous and implausible.
Although Mrs May and Messrs Corbyn, Trump and Pence may seem the most egregious offenders there are plenty of others to worry about, including those of Populist parties in government in Italy, Austria, Poland, Hungary, Slovakia and the Czech Republic and opposition parties in France, Germany, Sweden and the Netherlands. The newly-elected President Bolsanaro of Brazil is explicitly not interested in the welfare of all Brazilians even if investors love him to bits while Prime Minister Modi of India is losing his appeal alike to allies, voters and investors, albeit not to the same extent as President Erdogan. President Putin seems to have lapsed terminally into the traditional Russian combination of inferiority complex and territorial aggression and his military spending may yet prove as ruinous as that of his Soviet predecessors. President Xi may have more intelligence than most dictators but his preference for a command economy is already severely constraining the enormous potential of China’s economy. Somehow investors, who have in recent years had the luxury of ignoring political developments, will have to navigate the perplexing policies of all these headstrong leaders. This will be far from easy with so much quarrelling between and within governing and opposition parties as well as between nominally allied nations.
"Not The Golden Age"
The biggest economic threat is from constrained consumer demand
The above headline may seem commonplace in view of the dominant share of Consumption in the major economies (>60% in US and UK, 50-60% in the Euro Area and c40% in China) but it is central to the current debate over predictions in a range from global recession as soon as soon as 2020 through a patchy slowdown starting in 2019 to a pick-up as soon as mid-2019. Regular readers will know that I have for some time been quite gloomy about economic growth without fearing anything much worse than prolonged stagnation. The crux of my argument was over supply of just about everything: workers, commodities, manufactured stuff and even money. I am sticking with that while now looking at consumer demand, which is notoriously difficult to forecast. At the risk of upsetting those who rely on neat equilibrium models I offer a two-step (probably grossly over-simplified) argument:
- Most consumers are not really much better off in real terms than they were 10 years or more ago (figure 2). This is after adjusting for inflation, which is in itself highly contentious as it relies on what is included in the various indices (CPI, CPIH, RPI, PCE etc.). Somehow the ‘cost of living’ always seems to go up faster than the official indices. Figure 2 shows that average earnings have actually fallen in real terms since 2007 in Italy and the UK, have risen by less than 0.5% compound per annum in the US and risen by around 1% compound only in Germany. As an aside, this helps to explain the mounting social discontent in the Advanced Economies, especially when it seems most of any increases are going to the top 10% of earners. For now, I shall settle for the simple conclusion that the amount of money most consumers have to spend has barely been growing for a long time.
- Yet Consumption clearly has been growing, boosting World Output every year since 2009. Consumers generally have been borrowing to fund their spending on housing, cars and student fees as well day-to-day spending. Moreover, companies have been borrowing too in order to fund takeovers, share buy-backs and even (limited) investment in plant, R & D and IT. Professor Steve Keen has carried out pioneering analysis on the relationship between increased private sector borrowing and GDP with implications for the latter if and when consumers and companies deleverage or merely mark time. This is consistent with the conclusion of the late Hyman Minsky that stable economic conditions encourage banks to lend increasingly recklessly until the cycle ends in a credit crunch and economic instability. Apocalyptic warnings have become increasingly common, although the main protagonists of the 2008 crisis, the European banks, have drawn in their horns ever since while the major US banks have greatly strengthened their capital bases. If there is to be a credit crunch soon, the casualties will be the leverage loan funds in the US and their institutional and retail investors. Taking a more cautious approach, my conclusion is that consumers and companies over the next few years are going to be both less willing as well as less able to take on ever more debt and many lenders, faced with the prospect of their own ‘Minsky moment’, will be less willing or able to lend to them. Growth in consumption and business investment will slow even if it does not contract. Figure 3 gives a picture of which economies are most exposed: those already with high levels of debt (notably the US and UK, those making it worse (notably Australia) and those heading that way (notably China).
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Disclaimer: Economic Insights is written for commercial companies as well as institutional and other sophisticated investors and all opinions expressed in it are solely those of the author, Alastair Winter. Economic Insights is compiled from sources the author believes to have been reliable but it may not be complete or accurate on any particular subject. All opinions, estimates and analyses are or were produced at the date of issue and are subject to change without notice. Accordingly, none of the author, Daniel Stewart & Company plc, any one or more of its directors, employees and/or affiliates, makes any representation or warranty on any subject discussed in Economic Insights; nor do they accept responsibility or liability for any claim, loss, damage, expense or cost arising from reliance upon its contents, except in the case of death or personal injury. The value of investments may go down as well as up and any income derived from them may vary as is not guaranteed. This article takes no account of your personal circumstances and is not investment advice. You should consult a professional investment adviser if you have any doubts or require advice.
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