By Michael Every of Rabobank
Yesterday, I said a bomb might be being built under our global dollarised financial system while repeating that ‘Bretton Woods 3’, BW3, a new global system with no dollar, won’t work. (As Malaysia’s PM joins the list of those saying they no longer need US dollars.) Today I add that the current system, ‘Bretton Woods 2’, BW2, and the expectations that lower rates and the US buying everything from everyone while we all sing kumbaya once again, won’t work either.
That’s news for the RBA, who left rates unchanged at 3.60% yesterday despite hot jobs and retail numbers; and the BOE’s Tenyreyro, who called for rate cuts to stop an inflation undershoot while arguing QE was not inflationary, as UK inflation stays high and sticky, and unions win large pay deals in places; and those cheering US JOLTS job openings being back under 10 million for the first time since 2021. But tell it to the Fed’s Mester, who still wants to hike rates further, and keep them there for some time.
To explain why BW2 is done, start with geopolitics. President Macron is off to Beijing with an olive branch, but so is “let’s de-risk” Von der Leyen; Lithuania’s foreign minister just tweeted an undiplomatic broadside; and Italy is reviewing limiting China's Sinochem influence over Pirelli. Meanwhile, we wait for China’s reaction to Taiwanese President Tsai meeting US House Speaker McCarthy today. Also don’t forget President Biden is already running a US trade policy far more protectionist than his predecessor’s, who is running again on a platform of an open return to mercantilism - which is what much of the rest of the world relies on without declaring it.
Next, look at government debt-to-GDP (too high); household debt-to-GDP (too high); and corporate debt-to-GDP (not high enough outside China due to a lack of capex). Rate cuts are nicer than rate hikes for debtors, but neither they nor QE will push up private investment, as we know. And if we rely more on the government for growth, it will be even more protectionist.
The thought of rate cuts with inflation still high is pushing gold higher (and over $2,000), following oil. And if the last few years have not taught you that life is not a see-saw as Macro 101 peddles, consider this warning from @freightalley, in response to deflation in his US industry: “Trucking is a commodity. But unlike commodities that you can buy at low prices and store for future consumption, the commodity is perishable. You can’t store it. People don’t transport goods unless there is demand on the other end. Just because freight prices are cheap, doesn’t mean that companies will transport more products.“ In short, people won’t deliver stuff if it doesn’t pay them to – so you may get lower prices and no goods.
Meanwhile, back to debt again, also note:
In 1953, with the US in a Cold War vs. the USSR and China, and a hot war in Korea, bank debt liabilities were 4% of GDP. In 2023, with the US in a Cold War against Russia and China, and a hot war in Ukraine with preparations for a larger one in Asia, bank debt liabilities are 76% of GDP. That’s down from 122% in 2008, but overlooks that shadow banking assets (and so liabilities) have soared, e.g., insurance company assets rose 15ppts to 59% of GDP as of end-2020, and pension fund assets by 76ppts to 170%.
US mortgage assets rose from 26% of GDP in 1953 to 74% as of 2022, down from 102% in 2009.
Bank credit to the private non-financial sector only rose from 26% of GDP in 1953 to 51% in 2022, the latter the same as in 1972.
If you believe in BW2, you believe banks, shadow-banks, and mortgage loans can all keep growing as a % of GDP indefinitely. We saw how that ended for mortgages last time, and more broadly, as the Financial Times noted Tuesday, “We’ve moved from financialised capitalism to something more insidious – an asset manager society in which the titans of finance own “essential physical systems and frameworks” – the homes in which we live, the buildings where we work, the power systems that light our cities, and the hospices in which we die.”
Indeed, the logic of yet higher asset prices, implying eventual two-generation mortgages for those who can afford property at all, and lifetime student loans, sounds like neo-feudalism - diverse and inclusive for the asset managers, perhaps, but hardly equal for all.
If BW2 means no ability to fight inflation ‘because assets’, and leads to feudalism, alongside a US murder rate approaching that of medieval Europe and a mortality rate trending the same way, as a former president arraigned for a felony for what is usually a misdemeanour, it’s not an easy sell globally. BW3 might be easier to sell, but it won’t work without the US and the West. That leaves us all in the Deep Dark Woods, with the West and East both pushing for a new status quo.
On which, consider this review of ‘The Triumph of Broken Promises’ by Bartel, who uses new historical evidence to link finance and energy as key connected battlegrounds in the last Cold War, with lessons for today. It argues East and West both suffered stagflation after the 1970’s oil shock, and reached the same conclusion: “decades of promises made and delivered had woven a dense tapestry of contracts and expectations, all premised on high future growth rates. Given that those growth rates had declined, leaders on both sides regretfully observed, the promises built on them had become untenable. The upshot: promises had to be broken.” In the West, this meant Thatcherism/Reaganism, and in the East, perestroika – and only one worked.
Bartel also claims the West’s ability to separate “It’s the economy, stupid” from politics, and free elections granting painful decisions to break promises social legitimacy, gave it the flexibility Marxist-Leninist systems lacked because the Party *was* the economy. Indeed, both sides implemented austerity - but it only made political-economy sense in one. Then, “Thanks to the prior disciplining of the American working class and the Volcker Shock, Reagan’s massive fiscal deficits --a “financial build-up,” in Bartel’s felicitous phrase-- "achieved what his foreign policy could not: it soaked up global capital and thereby dried up lending to the Eastern Bloc.”
In 2023’s new Cold War, the US working class can’t be disciplined more and still work. However, promises of Fed Puts for Wall Street could be broken to help repeat the soaking up of global capital and drying up of lending to the Eastern bloc. Of course, such a ‘Volcker 2.0’ means more pain for some – but, proportionately, not the working class this time.
Here the Cold War also comes into play again. The Intercept says, ‘Pentagon tries to cast bank runs as national security threat’, noting under its new Office of Strategic Capital (OSC): “the Pentagon has moved to provide loans, guarantees, and other financial instruments to technology companies it considers crucial to national security - a step beyond the grants and contracts it normally employs. So when SVB threatened to fail in March following a bank run, the defence agency advocated for government intervention to insure the investments. The Pentagon had even scrambled to prepare multiple plans to get cash to affected companies if necessary.”
The OSC only has funding of a paltry $115m for now. Yet more such state support, on top of ending of mark-to-market for loans vs. key US assets, expanded dollar deposit insurance only within the US, and the tax incentives of the Investment Reduction Act, could allow for higher US rates, relative to others, soaking up global capital flows to the Eastern bloc.
Meanwhile, there are two sides to this story. Can China avoid Gorbachev’s errors in the USSR as its own growth slows? It’s read that playbook many times, as well as having looked at what the West has done so wrong for so long. Firewalls are being built even as foreign capital is wooed (and the French woo back). There is no glasnost. Moreover, Beijing just warned its financial sector that a crackdown will deepen and ‘common prosperity’ will channel capital to politically and socially important sector. That’s news to ‘BW2’ Bloomberg, drooling that ‘China Households to Cut Property in $18 Trillion Shift’, which they think will see money flood into financial assets that get them richer quicker than bricks and mortar. Yet as the government indirectly takes a controlling stake in its top speciality steel producer, and gets golden shares in tech and large commodities firms, China Beige Book notes: ”The state isn't empowering private firms, it's eating them.”
So, the East and West are mirroring each other again as they both grapple with the same problems, which is only natural given we all live on the same planet and were until recently the same global economy. It remains to be seen who can adapt better to inflation and the challenge presented by the other bloc this time: it may once again come down to whose promises to whom are broken.