By Michael Every of Rabobank
The Deep, Dark Bretton Woods
To summarize, the US economy’s state of play at the moment is: a record number of jobs opening up; yet far fewer people being employed than expected; consumer, producer, and import prices all going up much more than expected; yet nominal (and real) retail sales less so; as is industrial production; and consumer confidence - because inflation is seen soaring ahead. We can all argue about what happens next, but there are three intersecting stories worth nothing.
First, Elon Musk (again) getting into a vicious crypto Twitter battle (again), and implying Tesla may be dumping Bitcoin ahead. The result: Bitcoin trading at USD46,000 at time of writing when it was USD63,000 a month ago. Nice store of value there, while its means of exchange is still minimal, and accounting is done in the US Dollar. But don’t Tweet at me about it too, please.
Second, the Bank of Canada saying the quiet part out loud when admitting: "QE can boost wealth by increasing the value of assets such as the investments Canadians have in their registered retirement savings plans or company pension plans. But of course, these assets aren't distributed evenly across society. As a result, QE can widen wealth inequality. We will look closely at the outcomes of QE here and elsewhere and will work to more fully understand its impact on both income and wealth inequality." Yeah, go work on that impact-study while your pension pot and house price soars. No need to acknowledge heterodox economists such as Kalecki established that QE needed to be joined with fiscal stimulus to work decades ago, eh? Ignorance is bliss.
Third, we have a plaintive cry from The Guardian: “Why the landmark Bretton Woods deal is as relevant today as in 1944.” This may seem old hat when Bretton Woods 1 went defunct in the 1970s when the USD went off gold, and the Eurodollar Bretton Woods 2 is under sustained attack by America First, the US-China Cold War, and everything from the eCNY to Dogecoin. Yet the article underlines that under BW: “Out went the beggar-my-neighbour approach that had marked the 1930s. In came cooperation to ensure the rebuilding of economies devastated by war and the goal of full employment…The participating nations didn’t wait for the war to end before coming up with their plans for reconstruction. Nor did they think that the financial cost of achieving victory meant they had to rein in their ambitions. On the contrary, the experience of everything that had happened in the previous decade and a half – the Wall Street Crash, mass unemployment, the rise of fascism, the second world war – made a compelling case for radicalism. The feeling was that the system was broken and had to be fixed.”
Doesn’t that sound Build Back Better? Indeed, the Guardian hopes June’s G7 summit and the Cop26 climate change conference in November will “shape the world for the next decade and beyond.” However, as has been repeatedly pointed out here, it’s all very well having the lightbulb moment and realizing QE only makes rich people richer, and that it needs to be joined by fiscal policy; but it’s another to then do that without a trade-deficit/inflationary spiral – as we see; and that involves running a trade surplus, which in turn means on-shoring and/or automation, and less worry about global supply chains - and that is still essentially zero sum, just like the 1930s was.
Bretton Woods 1 and 2 only worked because the US was there to mop demand up. That is no longer the case, politically. Covid-19 has only underlined the political desire for change.
This means more than just slogans. Any true new Bretton Woods would logically need to include capital controls, like the first – which would massively disrupt markets. It would also need to have what the first did not, at US behest - a mechanism that punishes countries that run current-account surpluses as well as those that run current-account deficits.
We all know what policies the warm, humanitarian IMF rams down the throat of deficit countries, and how this ends up. Logically, we would need to see the IMF have the same power to order countries to stop being selfish and save less –e.g., via more investment driven by foreign inputs and/or tax cuts-- in order to ensure a more harmonious global environment.
There’s just one big problem: it is never going to happen. Can you imagine Germany being forced to slash taxes because its trade surplus is too high? (“Sein Geld auf die Straße werfen!”) Or China forced to invest in IMPORTED goods to lift all boats, rather than producing a new warship every few weeks, when a recent PBOC working paper rubbishes the idea of lower national savings and trade deficits as ‘historic national weaknesses’? Moreover, here is a Twitter anecdote from a US economics professor: “I gave a talk a few years ago to industrial leaders about this topic. I laid out a few scenarios of how to turn the Midwest into a competitor of Far East manufacturing, especially in critical components. They were all short-term focused (1-2 quarters out). One guy said he did not want to lose his frequent flier miles to China where he could shop.” Ruder comments were also made that recent developments show should reflect back on those leaders rather than the intended targets.
For those getting excited about the G7, world history is replete with key conferences that do not achieve anything, even with storm clouds on the horizon. The London Economic Conference of 1933, for example, during the Great Depression, with all sides racing to the bottom could not agree on a compromise; not even when the German delegation proposed a program of colonial expansion in Africa and Eastern Europe as the best way of reflating the economy!
So what does this mean for markets?
Tactically, we are still stuck with QE for now, even as it is recognized that it could never, can never, and will never achieve what it claims to do. The trading response to that is more of the same (“Buy all the things”), regardless of how ridiculous and dangerous our paradigm is. Yet this only inflames and polarizes societies, ultimately driving Western politics in a new direction.
Strategically, if/when we swing towards Bretton Woods, it will likely be to bifurcate the world between those building too many boats and those not, rather than to lift all of them. The UK is talking about the G7 transmogrifying into a D10 of democracies, for example. Yes, this may well be a slow process; and US industry “leaders” may not be doing any; but if the national security types who recall the 1930s, and are already echoing those fears, give them all a push, things may yet change faster than some imagine.
That’s likely to be bad for many net exporters and good for many net importers, and imply considerable changes in the structure of both sets of economies – and markets. To repeat, the prime years of Bretton Woods 1, which built the Western middle class now running on fumes, saw key bond yields capped, FX rates fixed for years/decades, and tight capital controls. Those are some deep, dark Woods for a 24/7, microsecond, crypto-Twitter focused society to contemplate wandering into.