From Capital & Conflict (GREAT BRITAIN)-
Can you feel the tension in the air? The bookies certainly can’t. Remain is comfortably in front, according to the oddsmakers. And the markets?
The markets paused yesterday. And here we are on the eve of the big vote and there’s an element of uncertainty back in play. Even Janet Yellen, the chair of the US Federal Reserve, got caught up in the zeitgeist of the moment.
“Considerable uncertainty about the economic outlook remains,” Yellen said in her testimony to the Senate Banking Committee. She said the Fed is still on target to raise the Fed funds rate twice this year. It wants to get back to a “normal” 100 basis points. But do you see that happening?
You wouldn’t find many people arguing that interest rates are headed higher this year, at least not by design. The world is in the grip of sluggish growth. China is bloated by debt. Technology and demographics are twin forces of deflation. It will take a mighty big printing press to generate 2% inflation right now.
Ever eager for a challenge, I took up the case for inflation in this week’s MoneyWeek magazine cover story. That’s out tomorrow. Here’s the short, advance version: policy failure leads to currency failure which leads to inflation.
Deflation becomes inflation faster than you can say “banzai!” More on that tomorrow.
Euro and sterling post Brexit
While I’m on the subject of central bankers who have no idea what they’re doing, Mario Draghi fronted a European Parliament hearing in Brussels. The president of the European Central Bank was there to discuss what other kooky ideas he and his cronies have to produce growth in a region that’s not experiencing much of it.
Draghi didn’t talk up European growth, because there is none to be talked up. He did say that further stimulus was “in the pipeline.” Just what kind of stimulus and what end of the pipeline, he didn’t make clear. But the euro fell as a result.
That sets up an interesting next 24 hours for currency traders. Should Remain win, you’d expect to see the pound surge against the euro. Britain will remain in the European Union. But relative to the weak employment and GDP growth on the continent, the UK will look relatively strong by comparison. Thus the case for UK equities made by Charlie Morris and Tim Price on the private conference call we had yesterday.
Back to building the deficit
Chancellor George Osborne will be happy to have the Brexit debate over. It must be exhausting trashing the prospects of your own country (and your own political future) every chance you get. Osborne will at least have time to return to his stated goal of reducing the UK’s annual government deficit to £55 billion, or 2.9% of GDP.
He’s already in trouble for the fiscal year. The UK’s budget deficit for the first two months of this fiscal year was £17.9 billion. The deficit for the first two months of the last fiscal year was £17.8 billion. Victory or failure?
Well, the deficit was negligibly larger. But it was noticeably smaller. And even a smaller deficit is still a deficit. Remember, last year’s total budget deficit was £74.9 billion. Total government debt is over £1.2 trillion.
If we’ve learned anything in the referendum campaign, it’s that a certain element of the Tory party (the leadership) is fiscally conservative in name only. Smaller deficits do not constitute debt reduction. Debt reduction would only come from faster growth, lower taxes, lower spending, and less regulation.
All of those things could be achieved with the UK leaving the EU. But it’s been the chancellor and the prime minister leading the charge to remain. How long they remain the leaders of their party will depend on how quickly fences are mended. And whether there are any real fiscal conservatives left in British politics.
The lowest yields in 500 years
Finally, a note to put in perspective how weird financial markets are right now. And dangerous. It might be something you missed if your attention was all (quite rightly) on Brexit. But government bond yields haven’t been this low in 500 years, according to Bill Gross.
A little more modest – but not less concerning – is the comment that government bond yields haven’t been this low across the board since 1871. That’s according to Jack Malvey, the chief market strategist for the Bank of New York Mellon. The chart below puts it in perspective, with more than $8 trillion worth of government bonds having a negative yield.
Do you remember where you were in 1871? It was the year Parliament legalised the formation of trade unions; Henry Stanley found the lost David Livingstone on the shores of Lake Tanganyika; and Queen Victoria opened the Royal Albert Hall.
1871 was right in the middle of what historian David Hackett Fischer called the Victorian Price Equilibrium. Prices move through history in a rhythm, according to Fischer. First you have a price revolution. Then you have a revolutionary crisis. Then you have an equilibrium.
The equilibrium is just what it sounds like: a prolonged period of stable prices (low inflation), sound money, real productivity growth, and growth in real wages. Life is good.
But no equilibrium lasts forever. Or in Hyman Minsky’s terms, stability creates instability. Equilibrium sows the seeds of the next price revolution and the next revolutionary crisis.
In my cover story for the magazine, I’ve taken the line that the triple forces of debt, demography and automation have undone the equilibrium enjoyed by the global economy since the end of World War Two. The dollar standard is buckling. But a new monetary system for a globalised economy doesn’t exist.
The question now is what the revolution looks like. And then, what happens in the revolutionary crisis? Will King Cash lose its head, to be replaced by digital usurpers like bitcoin?
Or will central banks and governments pull a rabbit out of their hats and replace the old money with something new? Something that allows them greater control and the ability to use money as a tool of financial repression?