Friday, 22 June 2018

Testing times

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I wonder whether we will be returning on Monday morning and re-writing the wise words of John Maynard Keynes who, having blown most the family fortune in the Crash of ’29, concluded that “Markets can remain irrational for longer than you can remain liquid”. 

Will Monday, April 24 2017 be the day on which it is updated to “Politics can remain irrational for longer than you can remain liquid”? 

Polls suggest that last night’s attack on the bus full of Parisian police officers on the Champs-Elysées will have no immediate effect on voting patterns and that positions taken ahead of Sunday’s first round of voting are pretty well set. Although it is said that the French vote with their hearts in the first round and with their heads in the second, I do quietly wonder whether the centre vote might not just coalesce around Emmanuel Macron to the detriment of François Fillon.



On the other hand, if there is a sense that any of the four leading candidates has a decent chance of making it into round two, then the chances of any tactical voting taking place diminishes rapidly. As we stand this morning there are still many variations on the theme although I’d suggest that the original outcome of a Marine Le Pen/Macron second round run-off still seems to be the most likely. 

Deutsche Asset Management reckons that there is a 70% probability that one of the two centrists will take the presidency, which would seem to infer that it does not rule out Fillon making an appearance in the second round. I’m not sure that is quite what they mean but rather that they only rate a 30% chance of both Le Pen and Jean-Luc Melenchon making it to the run-off and that if one of them does, he or she will be slaughtered in the second round. That is of itself not rocket science but they conclude that if their core scenario plays out as they expect European markets are in for good bounce next week as the substantial risk premium that is built into asset prices is spat out again. “Le Spread”, the yield differential between 10-year France and 10-year Germany, sits this morning at 91bp. Deutsche reckon that seeing a centrist in the run-off will have the spread snap in by 30bp, not doing so would prompt a widening of 100bp and a concomitant dump by the euro. 

Please don’t get me wrong but from a purely academic perspective I’d love to see what would happen if it were Le Pen versus Melenchon. The verification of a system requires it to be tested to destruction. Many of the tenets of our modern parliamentary democracy were forged in response to the terror and the blood of revolutionary France under Maximilien Robespierre. Extraordinary levels of debt have been piled up during the past decade in order to lock out what Joseph Schumpeter termed “creative destruction”. 

Fortunes have been spent in both the US and Europe to prevent structural reorientation and every time a crack appears in the existing edifice more billions and trillions are thrown at it in order to maintain, on the surface at least, the status quo.



The zombie economies in Japan and Europe have much to do with a failed understanding of Keynes. What is generally referred to as Keynesian economics has in a modern context little to do with what the old man was intending to postulate. He proposed that deficit financing should be utilised to smooth the path of the economic cycle, to reduce its amplitudes and not, as it is now understood, to stand in its way or even to block entirely the playing out of the economic cycle. Fiscal deficits in downturns were to be countered with surpluses during recoveries. How an economy with 70%, 80% or 100% debt to GDP to service will ever be able to run anything more than a primary surplus is hard, if not impossible, to fathom. Celebrating Greece running a primary surplus is tantamount to the first mate on the galley announcing to the oarsmen “The good news is that we’re giving double rations today; the bad news is that it’s because the captain wants to go water skiing…” 

I dined last night with a pretty senior real estate chap and we discussed, as one does, life, the universe and everything. We agreed in the end that the opportunities that existed in 2007 to take the pain and to deleverage the global economy were missed by a political class that feared the repercussions of being found guilty of, to use the infamous Chuck Prince line, dancing on long after the music had stopped. 

The result has been an eye-watering increase in indebtedness – aggregate indebtedness as a proportion of GDP has risen in 2010-2016 by 44.7% in the US and by 43.5% in the UK – and at some point the music has to stop. Every year that passes without the boil being lanced makes the problem worse. One day the issue will have to be faced up to and a Le Pen/Melenchon result could quite possible be the trigger. 



The chances of a gradualist approach to rebalancing government expenditure seems to be failing as deficits, despite all the austerity rhetoric, are simply not falling. Give a man a steak once a month and it is a treat; give it to him every day and it becomes an entitlement. Thus the problems we face with social services. Another friend of mine, a now-retired senior nurse and life-long servant to the NHS, frequently exclaims in frustration over the endless demands for more and more investment in the health service, “What part of ‘we can’t afford it’ do they not get?” 

It might seem bizarre that in the context of a possible left/right populist surge I foster hope that it might lead to putting economic rationality and fiscal discipline over everything for everybody. It is never too early but always too late to challenge “entitlement-ocracy” and nothing would do that better than the emergence of that worst case scenario in France. 

Risk asset markets surged yesterday with the Dow closing up 174.22 points at 20,578.71 and the Nasdaq even had the temerity to close at a new all-time high of 5,916.777. Initial claims were slightly ahead of expectations at 244k against the forecast of 240k but continuing claims registered at 1,979k, well below the 2,024k predicted and the lowest weekly reading since 1973. Mixed messages from hard and soft data continue to baffle. 

Alas, it is that time of the week again and all that remains is for me to wish you and yours a happy and peaceful weekend. Easter is out of the way, the parents have packed up and gone back home and the children are back at school. No better time to sit down with the better half and plan the summer holidays. Jemima is too old for the quiet of a chalet in the Alps and Freddy is too young for the flesh-pots of Cote d’Azur. May I humbly suggest considering a motoring holiday taking in the likes of Rome, Florence, Pisa, Paris, Carcassonne, Barcelona or wherever. I would even strongly recommend Cologne, Heidelberg, Rothenburg ob der Tauber and Munich. We need to do that now that schools have decided that culture is a waste of time and that it’s more important to teach… well, I’ll let you fill in gaps. 

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