Chief Economist & CIO
Summary: In 1976, the author Astrid Lindgren of Pippi Longstockings fame incurred a 102% marginal tax rate by the Swedish Government, she countered by writing a satirical fairytale, "Pomperipossa in Monismania" - I think the title explains itself. She not only raised a fierce debate but also imparted a major loss on the Social Democratic government in elections later that year, as they lost power for the first time in 44 years.
I bring you the story because Astrid Lindgren's main argument with the government was the overreaching power of government to not only tax her, but to decide everything. Pomperissa in the book exclaims: "102%, that’s not even possible". Well I think the lesson over the last two months is that everything – literally everything – is possible.
Over the last couple of months we have seen austerity abandoned, central banks losing independence, fiscal rules in the EU out the window, infinite QE all around the world, an explosion of the Fed’s balance sheet to bail-out Wall Street and high risk corporate debt, billions extended a bit less efficiently to bail-out Main Street, an introduction through the back door of Universal-Basic-Income (grants), Modern Monetary Theory (Monetizing debt of government through central banks balance sheet expansion). The most aggressive actor in all of this, the US Federal Reserve under Chairman Powell has ripped open swap lines to global central banks and in some of its more creative moves has violated the Federal Reserve Act by by using SPV's, yes that old chestnut, to "make everyone whole".
The make everyone whole argument is a descent into terrible moral hazard, as we now not only abandon price discovery, but also the market based economy. This bailout means that airlines executives who left no cash on their balance sheet, and who allotted themselves 100 of millions of stocks in options through depleting the same balance sheet with massive stock buy-back programs. Or take IBM, which has spent $157 billion worth of stock last ten years but has a current market cap of $102 billion. Maybe we need to call on another Scandinavian author – the Danish H.C Andersen and his fairy tale of "The Emperor’s new clothes” – to fully understand what is going on.
The infinite support in all shapes and forms means we now have paradigms and business models which should not be possible: Negative Interest Rates, being paid to borrow money, and even this week, negative oil prices, or being paid to consume fossil fuel. I could try to explain why everything is at it is, but the task is simply too tall, because it just doesn’t make any sense. Sure, I can come up with a “talking head” explanation, but this market environment is simply too nonsensical to understand.
What is clear though is that both negative yields and negative oil prices are a function of 'Pomperissa in Monismania' - government and central bank policy overreach. Government has replaced markets in determining prices and therefore supply and demand. Oil got too cheap – and briefly negative because of the "free ride" enjoyed by oil producers in subsidies and mal-investment inducing low interest rates. This "support" kept marginal operators pumping oil despite never having realized a positive cash flow, even when oil prices were much higher. Simply put, oil prices have now also reached the zero bound as well and more importantly, as my friend Mark Voller told me this week, we now have 'liquid, but insolvent companies' operating in all sectors but in particular in the ones with big jobs, big investments and of strategic importance. Welcome to Monismania!
The 1970s started with big government and a strong USD and saw the USD weaken all decade and then high inflation and high unemployment after Nixon depegged the USD from gold in 1971. Marring the decade were supply constraints and terrorism. Geopolitics saw the enlargement of the EU, the opening up of China. Environmental policy crept up on the radar for the first time.
And now? We have in my opinion gone full circle over the last 50 years and learned absolutely nothing. The first Earth Day was exactly 50 years ago today, and the environment is an even bigger issue today with our ever more anthropocentric world view, China is at risk of being "cut off", the USD is very strong and is still the world’s reserve standard – a standard the world desperately needs to de-peg from as the US Fed and government have decided to pay anyone holding US debt with IOU's based on printing money. EU membership has peaked will most likely be reduced again (Who will be first, Hungary?, Italy?).
Inflation is still lacking despite the desperate policy attempt to “achieve 2%”. But the bottlenecks and real capital destruction this crisis has created, together with infinite spending and grants to make everyone whole will see inflation returning again with a vengeance, sometime in the next two years. Unemployment is hitting 20% or worse in the US, and it will eventually fall, but 100-million plus American families have been impacted for this "inconvenience" here and now, and the UBI-type programs will act a bit like old trade unions did by requiring companies to bid up labor costs to get people to work any job. In short, welcome back to the 1970s.
What however concerns me more than the resonance with the setup in the 1970’s is that other aspects of our current situation remind me of the Post World War One time-frame. This was the last time we saw truly massive sovereign debt failures. This time around, Ecuador has already declared bankruptcy, African nations have received an eight month moratorium and Argentina has declared its own moratorium and told creditors to get lost. In the Middle East Oman and Bahrain are effectively shut out of the bond market and are seeing their CDS prices (default insurance) rise and rise.
To understand the true impact of debt and potentially failed debt, read this article on how the UK only a few years ago repaid the last debt from that era, with Germany doing so in 2010 and the US still "making everyone whole" (Though I am sure Fed is ready to print some more money to help out.)
The two tables below are from Sovereign-debt relief and its aftermath: The 1930s, the 1990s, the future? by Carmen Reinhart, Christoph Trebesch, 21 October 2014
Look at the debt forgiveness needed in 1930s: France at 52% debt relief relative to GDP, the UK at almost 25%, Italy at 36% and Greece at 43%.
And here is an "instructional chart" on debt crisis:
My point?
France President Macron raised a critical question on Friday in the F.T - Is Europe a political union or a mercantile club? The answer needs to be answered this Thursday at the EU Council meeting, but I think we all know the answer. If so, there will be countries leaving the EU and soon, and on that note, the ultimate risk of sovereign defaults is on the line.
We monitor Italian BTP's (sovereign debt) as the proxy for the belief that the EU holds together. The BTP market is sending stress signals despite the fact that most italian debt is in domestic hands, but we may soon have a situation where being part of a mercantile EU club no longer makes sense, when there are no goods to trade and the legacy of past debt is denominated in a currency Italy can’t directly control. Also if the Covid19 crisis is not the time for Europe to step up and act in total solidarity, when is the time?
Most important though, the real reason for a break-down of sovereign debt is not the collapsing international cooperation but the fact that governments and central banks have gone too far this time in bailout Monismania.
Remember that the integrity of government financing is based on one thing only: the infinite ability for government to tax its companies and citizens. What we will see over the next ten years will be similar to what we saw in the 1970s, bigger and bigger government ownership of companies, dictating business and boardroom decisions, less and less return on invested capital, but also much higher taxes on first technology companies, but also other corporates and financial income. The VAT will rise, as will inheritance taxes and real estate taxes. Deficits will keep growing, but will be more affordable this time around because of the brave new world of Yield Curve Control, which will keep funding for governments artificially cheap and devalue past debts as inflation vastly exceeds policy rates. This is the very definition of financial repression and will lead to a massive bull market in tangible assets. It’s not new, either – the Fed was tasked with yield curve control after WWII to devalue the stock of US treasury debt used to pay for the war effort.
Prepare yourselves, as the world is fast accelerating to a place of no price discovery, one guarantor of all risk good and bad, higher taxes, and big society changes. This will require that we recalibrate the "good life" we have gotten used to.
Astrid Lindgren forced a government change, I am absolutely sure the over-reach and 1970s style government will do the same, but first this policy response needs to fail. Only through failing will we learn. That's the combined lesson of 1920 and 1930s, the 1970s and now 2007/2020.
Bond. Long Bond(s)
With real rates being too positive, we see three scenarios: Opportunity to lock in rates at cycle high, government overreach to keep the economy afloat or a complete reset of the economy.
Steen Jakobsen,
Chief Investment Officer
Is a bond bull market ahead? Inflation still poses a risk for investors, but the moment for increasing duration to your portfolio may be approaching towards the end of the year, when central banks might be forced to cut interest rates.
Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
Market Strategist
With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
