The Great Financial Crisis (GFC) of 2008 has left many cadavers in its wake; zombified economies with under performing companies kept under life support by a presumed modern monetary theory, not too dissimilar to what Japan embarked on in the late 1990s. Quantitative Easing where the quantity is never enough, and the pressure is such that central bankers have become suppliers of a drug the system is unable to leave without.
Too Big To Fail or too desperate to remain in power?
A brief summary
It is important to understand the current context before delving more specifically into the United Kingdom's case.
The United States 10-Year Treasury yield "climbed above 1.7%, a 14-month high" according to FXstreet.com.
Those who have benefited from a low yield, low inflation and low growth environment have been turning to the Federal Reserve (Fed) to implement a stringent yield control policy or in other words announce that Operation Twist is alive and well. Fed chair Jerome Powell has little room to manoeuvre as the economy remains on life support despite promises that presumably pouring money into the system would make people spend and re-energise the economy.
In 2008, a shift happened. We have now stepped in a world where the most valuable companies usually known as GAFA (Google, Apple, Facebook and Amazon) have seen their valuation shoot the roof and into the unicorn stratosphere whilst main street has seen a decline in investments. Besides the number of users, it is difficult to apply basic production model based on land, capital and labour to appreciate tech companies' value-add on the economy.
Tech valuation may be one consequence of the Fed's policy, but there are other issues. For instance, the fact that central banks have created an illusory solution designed to save the real economy, whilst it is actually destroying it.
The spread between what is happening on the grounds and financial markets is deafening and is akin to a full-blown dislocation between reality and financial insanity. For instance, last year Tesla became the most valuable car company in the world at $190bn with shares going past $1,000. This is in spite of negative reports around accidents, death and issues surrounding its autopilot feature.
Disruption on the horizon? Perhaps. This is related to profit, or lack thereof.
Companies have resorted to immigration to promote low wages or in some cases have simply moved manufacturing jobs overseas to reduce labour cost.
There may have been many demonstrations or acts of civil disobedience to protect the environment, however not many people have boycotted brands because their products have been made in terrible conditions. In fact, people would not be wearing or using many products if that was the case. Bringing manufacturing jobs back in the West means increasing production cost because labour laws would have to be considered and such cost would have to be passed on to customers. With the effect of the pandemic reeling, people will not be able to afford it.
The only way to maintain profits is to keep manufacturing and production cost low. Additionally, without buybacks and the issuance of bonds will these companies be valued as high as they are?
This raises another point, especially as companies and economies turn to debt to maintain the system. It has become the latest tool to avoid social unrest or a recession but at what cost?
Spotlights on European debt
Debt is a compounding factor in this economic ecosystem heading for a rude awakening.
As stated above, debt has been used as a bandage on a gaping bleeding economic hole. Central banks issued more debts to protect the system.
This is especially true with the European Central Bank, former ECB chief Mario Draghi, who has now been parachuted as the Prime Minister of Italy, famously said: "within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe it will be enough." Was it enough?
At the peak of the Greek debt crisis, the country's 10-year bond yield rose to 35%, it now stands at around 1% with debt ratio to its GDP (Gross Domestic Product) at just over 200%. Italy is not far behind whilst France does not fare any better with debt to GDP standing at 125%. With the United Kingdom and the United States gearing up to reopen their economies following a successful vaccine roll out, the Eurozone is heading for a prolonged recessionary period with governments imposing lockdowns to mitigate the spread of the disease as their vaccine roll out campaign stalls. Find out more by watching former Portuguese Europe minister Bruno Maçães' discussion with The Sun's Steven Edginton about Europe's vaccine failure, and the future of the EU.
This is not a good time to have European debt products on one's portfolio.
Let us be honest here. The Greek debt crisis has demonstrated how weaponizing ones' debt can pummel even the most recalcitrant countries into submission. Be under no illusion, Italy has followed a similar path; bonds yields rose when Silvio Berlusconi was in power. Despite the political mess, the country's debt to GDP has risen above 155%, and yet no yield in sight.
There is no way out, at this time, for countries such as Italy, France or Portugal to consider leaving the Eurozone because their enormous debt and poor performing economies would struggle to compete on financial markets, especially with China launching its own bonds. These countries are reliant on better performing economies such as Germany and The Netherlands to guarantee their debt under the European umbrella.
French economist Marc Touati argues that in trying to save the Eurozone, decision makers are hastening its demise. He raises concerns about the ECB's inability to weather any upcoming storm, be it inflation or higher bond yields. Many central banks have reserves enabling it to print money whilst the ECB is using its printing press to buy bonds without holding these reserves in the first place.
Not everyone has been on board with Mario Draghi's 'whatever it takes' mantra as stated by the late Vincent Brousseau, a former economist at the ECB; "In the fall of 2019, a number of former top central bankers co-signed a highly critical memorandum on the euro and Mario Draghi."
Touati explains that inflation or a rise in yields could have devastating consequences for the Eurozone. With the ECB quickly running out of options and ammunitions, who would step up to save the Eurozone? The Bundesbank? In May 2020, Germany's constitutional court of Karlsruhe ruled that the European Central Bank's mass bond-buying programme to stabilise the eurozone partly violates the German constitution so Germany's Central Bank may not be able to support the bloc. Will Germany request guarantees from other member states? What will be the position of the new chancellor as Angela Merkel bows out of politics? Only time will tell.
"The world's a stage" (William Shakespeare)
In July 2020, French president Emmanuel Macron and German Chancellor Angela Merkel's plan for €500 billion recovery fund as the first step towards fiscal union. From Project Syndicate to Libération (just to name a few) Europhiles hailed the plan as a presumed defining moment for the bloc but is it? Doubtful.
Sony Kapoor posits that the presumed recovery fund was "just a damp squib". He argues that: "The longer-term consequences of the fund itself may also prove to be negative. It has killed any genuine prospect of a true, much needed Eurobond for good, leaving any "Hamiltonian moment" for future, potentially weaker, leaders. Even worse, absent future political agreements, the need to repay the debt incurred by the recovery fund will hollow out the already scarce EU budget."
The pandemic may be providing cover to an ever-growing debt problem, which keeps being postponed, ignored or temporary mitigated by announcements of outlandish packages worth billions. However, if the neediest countries are not seeing a penny then what is the point of this charade? Governments and central banks have issued more debts in the form of bonds to keep up appearances.
With the United Kingdom now out of the European Union, budgetary discussions have been increasingly difficult with more countries demanding a rebate and few wanted to plug the hole left by the UK's departure.
There are countries such as The Netherlands fiercely opposed to any fiscal union whilst others such as France or Italy preaching solidarity to solve their growing debt problem. These issues are further exacerbated by a growing problem in the financial market, one that is seldom talked about, the Eurodollar.
GFC coincided with an even bigger crisis, the collapse of the Eurodollar system.
Eurodollar system is broken
"The term Eurodollar refers to U.S. dollar-denominated deposits at foreign banks or at the overseas branches of American banks." There is no connection with the euro currency or the Eurozone, the only probably explanation about the prefix euro is that it originally in Europe, more precisely in London. This is an unregulated part of the market, not under the jurisdiction by the Federal Reserve. According to Martin Armstrong, a man once dubbed by The Wall Street Journal as the highest paid adviser in the world, about 70% of paper dollars are outside the United States and any country can issue debt and bonds in dollars. He adds that this is what makes the dollar the world reserve currency, not the fact that commodities such as oil are priced in dollar.
However, the Eurodollar system ceased to function properly around the subprime crisis. Jeff Snider, Head of Global Research at Alhambra Investments is of the view that GFC could probably be attributed to this crisis on the Eurodollar market, has led to dollar scarcity. There is not enough dollar to plug this hole no matter what the Federal Reserve does.
This explains why China is attempting to price oil in yuan rather than the dollar. The petroyuan is not an attempt to displace the dollar but a mean to reduce the country's dependency on dollar.
The moral of the story is the Eurodollar system is broken and there are not enough collateral products of good quality to go around to rebuild trust between lenders/ creditors and debtors/borrowers for the system to repair itself.
The United Kingdom, an ideal opportunity
As stated above, China is hunting for capital and so is France. Our neighbour across The Channel has launched CAC40 ESG (Environment, Social, Governance) – presumably aimed at promoting responsible and green capitalism.
BlackRock's Isabelle Mateos Y Lago has been promoting sustainable investment for some time now. However the company's own the former ESG chief Tariq Fancy begged to differ on the efficacy of these products claiming that greenwashing Wall Street is a scam (see articles here and here). Perhaps Rishi Sunak, Chancellor of Exchequer, needs to rethink his position on green bonds, especially following France's launch of green bonds at the height of COP21 with limited success.
Besides, green bonds, the Chancellor of the Exchequer also announced several tax hikes, which can be mitigated with capital inflow. When it comes to actual budget, Spiked Online is pretty much on the money whilst Lord Jonathan Hill report offers enlightening views on the City's competitiveness. His recommendations constitute the most interesting part of the budget. Two key takeaways, he advised that "this report is not about opening up a gap between us and other global centres by proposing radical new departures to try to seize a competitive advantage. It is about closing a gap which has opened up." Nonetheless, one must remember that policy homogenisation is akin to herd mentality, it prevents politicians from doing politics and encourage all decision makers to reinforce the same narrative. It is worth considering that those suggesting these ideas are only fearful that a competitive system will emerge challenging their presumed power.
Lord Hill covers Amsterdam's emergence as a competitive financial centre on the continent, weeks after it toppled London as the main share trading market in Europe. He also points out that special acquisition purpose companies (SPACs) have also taken financial markets by storm. These shell companies designed to take businesses public without going through the IPO (initial public offering) process have been battered of late. The King of SPACs Chamath Palihapitiya recently warned of "bunch of busted IPOs / Mergers ahead". SPACs are indeed risky business; WeWork, which lost $3.2 bn last year is closing in on a SPAC deal whilst Axios eyes a SPAC deal to mitigate the impact of the loss of traffic with the departure of Donald Trump from the White House. These products need to be carefully thought out should London wish to embark on this path.
The second point raised in the report is the following: "The truth is that the task of improving London's competitiveness and of strengthening our financial ecosystem should be seen as a task that is never complete, not a one-off." This can only happen if the European Union must not retain any influence in the United Kingdom as the two sides resume talks over the term of a memorandum of understanding, which would grant London access to the European financial markets.
The United Kingdom is in a unique position to re-invent a system, which is in desperate need of innovation. We cannot be bound by rules made on the continent. It will be an innovation killer.
Here are a few suggestions:
- Reduce our exposure to European debt products.
- The Bank of England should lend to the Treasury by using fixed interest rates to prevent Government debt from fluctuating.
- Increase rates slowly to attract investors looking for a haven for their capital.
- Develop products for emerging markets – maybe with a commonwealth angle.
- Prime brokers could use margin calls to reduce their exposure to risky products.
- Invest in farming land in the UK for instance.
- Avoid playing politics with capital so develop a competitive place for exotic products.
- Strengthen the country's borders to welcome only those needed to develop our economy.
- Do not use Special Drawing Rights as a mean to improve liquidity – basically kill this idea.
Mimetic actions on financial markets have left central bankers and politicians scratching for ideas to ensure that the system does not collapse but an increase in debt and the promotion of idiotic programmes only designed to occupy space in broadsheet papers will only delay the inevitable.
The fact that the personnel at the top of the echelon has not been renewed should give us pause. So far, we have seen (presumably) retired Fed Chair Janet Yellen moved to the American Treasury department with former ECB chief Marion Draghi take the premiership in Italy (without elections). Former Chair and Managing Director of the International Monetary Fund Christine Lagarde is now at the helm of the ECB. The revolving doors between institutions has only served to reinforce the echo chamber in a group, which feed on the same ideas. This line up will almost be complete if Brussel's negotiator Michel Barnier is crowned France's president in 2022.
One thing is for sure is that we cannot expect the same people whose policies have been the root cause of this mess to find solutions.
The United Kingdom is in a unique position to lead the world out of this debt-ridden cycle and into a new paradigm. Is our government ready for the challenge? Brexit is not done until it has materialised into profound structural changes for the country and its population at large.