By Michael Every of Rabobank
Just because you're paranoid...
I’ve mentioned it before, but growing up one of the family friends where we spent a lot of our time had a poster on their kitchen door: “Just because you’re paranoid doesn’t mean they’re not out to get you.” That kind of messaging sticks with you as an impressionable child. It also comes in handy sometimes as an adult.
After all, we awake in Asia to markets having stumbled, US stocks down around 2%, and US 10-year yields back under 2% again. Risk is very much off. Part of that is the Fed’s Bullard having again backed 100bp of hikes by July, this time adding that the Fed may have to overshoot the Fed’s neutral target rate of 2%, implying more than 8 hikes from here. Part of it was markets noticing a note floating around yesterday from Wall Street analyst and ex-NY Fed liquidity specialist Zoltan Poszar, in which he stressed the Fed needs “a Volcker moment”, with emphasis on the “vol”, to push either short term or long-term rates higher in order to curb inflation, even if that comes at the cost of lower asset prices and growth. As the poster said, things are out to get markets.
I have been making the point for a long time here that our current economic paradigm doesn’t work because neoclassical and neoliberal economics are full of holes. That is why we were until recently in the “new normal” nobody saw coming, and lasting. This week I’ve shared a paper co-authored by Martin Wolf which argues global capital flows into the US --which mean global free trade with the US, because the current account deficit mirrors the capital account surplus-- destroy first US, then global productivity, which is another puzzle nobody saw coming, and lasting. Even the US Trade Representative seems to tacitly agree in part. Yesterday then saw UK Professor Brian Bell, head of the government’s Migration Advisory Committee, argue current upwards pressure on wages at the bottom end of the jobs market suggests economists underestimated the downward pressure on wages from free movement; and that immigration in recent decades hasn’t made the UK richer, or made much economic difference.
So, some credentialled experts say free capital flows are bad; and free trade is bad; and free movement is bad. What is there left then? Free money!
As has also been explained here over and over, free money does not provide any solution to the structural problems described above: it papers over the cracks at best and exacerbates them at worst. We all agreed around 18 months ago, and ‘went fiscal’ again. Yet if you add ultra-loose fiscal policy on top of ultra-loose monetary policy you end up with inflation unless:
- you are the only one doing it – and why should you be the only one doing it?; or,
- you have excess physical capacity – which we off-shored according to neoclassical and neoliberal economic theory.
Logically, we stay where we unhappily are right now, with high inflation and fading growth; or rates stay ultra-low to finance the government boosting physical capacity via industrial policy, subsidies, and forced onshoring of supply chains – so MMT; or you have to raise rates to make it more attractive to invest in physical production and supply chains rather than speculation in financial assets. (The latter being a point made repeatedly by always interesting @ektrit, who combines liquidity and theology.) Yet MMT then means the need for protectionism/decoupling; and raising rates means your exchange rate soars if only you do it --and why should anyone else do it if you are?-- so again implies the need for more protectionism/decoupling.
It’s not paranoia – the underlying illogic of how we have built things is out to get you.
The question I personally focus on is how many policymakers grasp this truth, and what they believe are the best solutions available. My suspicions are almost none and almost none. So, perhaps we can squeeze a few more years out of this failed paradigm yet, until someone has the intestinal fortitude to join the dots and offer an alternative model. Which *is* happening in geopolitics, which is also hitting markets.
Again, the US are accusing Russia of lying about its troop withdrawals and warning of an imminent invasion of Ukraine: The Times says the UK government has concluded Putin has decided to do so, and it will “be horrendous.” The US is even flagging potential false flag chemical weapons attack as a casus belli - and that may not be needed given Western media reports of shelling in eastern Ukraine, and Russian media reports of mass graves and Ukrainian invasion plans against Russian-backed regions.
It’s easy to look at the stumbling US military-industrial complex and conclude D.C. is trying to instigate something: some mutter a distraction from, or a fig leaf for, the mess the Fed is about to make. However, this denies agency to the stumbling Russian military-industrial complex, which also instigates things to change the global architecture to its benefit: and it is the one with 150,000 men on Ukraine’s border, and demanding the US remove all troops from central and eastern Europe or face a “military-technical measures” as a response, while knowing full-well the US and Europe cannot comply.
The parallel is with economics, where the neoliberals and the MMTers are wrong – perhaps the US and Russia are both wrong too. Regrettably, the parallel continues in that geopolitics is also unhappily stuck, its old policy solutions are failing, with risks of serious volatility ahead, and logically ending with decoupling. Markets are right to worry. (On which note, we just released a report looking at the potential impact of war/sanctions on the global economy, which even given the rigidities that macro models impose, produces some uncomfortable economic and geopolitical conclusions: see “How We Would Pay for the War”.)
Meanwhile, we see the same domestic dynamic in places one would not have imagined until recently. Despite pushback from a major civil liberties group, the Canadian government is moving ahead with arresting protestors and freezing their bank accounts, with the justice minister stating one’s political opinions have a bearing on the latter. The Guardian claims Canadian intelligence services believe the protests are “a trigger point and opportunity for potential lone actor attackers to conduct a terrorist attack,” and are “advocating civil war.”; the Prime Minister dubbed them swastika-wavers. In our deeply polarised times, people will read this as they do US warnings over the Russian threat - though not necessarily in the same way. Even The Economist, which says “Russian military build-up enters a more dangerous phase” and bashes Putin, also says “Justin Trudeau’s crackdown on protests could make things worse – By seeking to curb free speech, he will aggravate Canada’s divisions.”
In short, we can’t agree on how the economy, or monetary policy, or fiscal policy, or supply chains, or inflation actually work; geopolitics is impossible to ignore; and firms and banks --and physical supply chains-- are being dragged into political (and geopolitical) issues they would never normally want to touch given the risk-reward for doing so. Worse, all these trends conflate and reflexively drive each other, with no clear indication of how it resolves – except towards protectionism/decoupling of sorts.
Happy Paranoid Friday. At least *I* am not out to get you!