The boat that rocked

9 min read

Given that we are at the beginning of a new but foreshortened week which has Western markets running at half speed with school holidays in full swing ahead of the unusually late Easter festival this is, from a market perspective, not a good time to be rocking the boat.

But it has been rocked and, quite possibly, in a pretty major way.

The Trump administration has rocked the boat and in a not too modest fashion either. Forget the up-coming G7 foreign ministers’ meeting in Lucca, Italy, forget the incredibly confusing labour report out of the US on Friday and forget Sergio Garcia’s stunning and long-overdue play-off victory in the Masters. I might even be tempted to say forget the horrendous palm Sunday bombing of two Coptic churches in Egypt. There is something much bigger afoot and we overlook the potentially much greater meaning of it at our peril.

I am of course speaking of US cruise missile attack on Friday morning. Please bear with me.

I last night dined with the deputy treasurer of a UK-based foreign bank. The gentleman in question happens to be also an intelligence officer in voluntary reserve of the British armed services. It did not take long for us to find ourselves discussing the attack and its ramifications. There is a school of thought that points to the fact that there were no Russian casualties in the attack pointing to Moscow having had enough notice to pull its nationals out of the area. Had it wanted to, it could have left them, taken the nominal sacrifice and used that to crank up the geopolitical temperature.

FACE TIME

The question being asked is whether Russia might know that it is on the wrong side of history but that it is currently not in a position to simply walk away. It too must save face. Thus all the kicking and screaming in the UN is for the benefit of the gallery but remote from the underlying currents of a new order in the making.

Trump the Disruptor is maybe not as unpredictable as is commonly touted. What he is doing is shaking up a rather moribund consensus that doing nothing is better than doing something untested and which might, as noted, rock the boat. Truth is that we are all wrapped up in a cosiness of the devil we know. Despite all the fine rhetoric and the massive increase in regulation, the economic model we are running is still exactly the same as the one that rode us into the global financial crisis. The Financial Times this morning carries an article pointing to the burgeoning problem of student loans, which suggests that of the 44m people who between them owe US$1.4trn, 8m are in default. And, in stark contrast to what has been done to the public debt markets, the student loan space has remained dangerously opaque.

Veterans of the financial crisis might recall that the it broke out not because of a bunch of defaults but on the back of the interbank market drying up because everybody became aware that they no longer knew where the risks were lodged, should the system blow up. The securitisation of mortgage debt meant that not even the monetary authorities knew who had which risks and in what quantity. The logical solution to the abstraction of risk through securitisation would have been to reign in the ABS market. Instead, and in the knowledge that the best way to keep an addict quiet and undisruptive is to keep his supply of drugs coming, the monetary authorities have encouraged securitisation. In fact, through QE, they have become among the biggest buyers.

PROPS

The point I am making, if you permit, is that going on 10 years since the crisis we have made little to no progress. Greece is still being propped up, as ridiculous as it is. The Italian banking system is being propped up, as ridiculous as it is. And kids are going off to college only to come out with no jobs but with a pile of debt, as ridiculous as that is too - but at least they can say that they didn’t miss out on having fun. Meanwhile, tomorrow can wait.

The Syrian situation has now been dragging on for six years with endless words of good intention being passed around but on Friday Trump slammed the table, which rather rudely woke up the complacent many. The rhetoric over the weekend has largely been a plea to let them go back to sleep again although the alarm clock seemingly refused to go from snooze to off. Trump, in his inimitable way, is causing a whole lot of rethinks that before long will not only be affecting the political stage but the financial one too.

Should Dodd-Frank be rolled back as announced, banks will be able to lend off their balance sheets again and the need to securitise everything and anything may fade. With that the very opaqueness that led to the crisis might also diminish, thus avoiding a second one.

The Socratic paradox – I know that I know nothing – is being replaced by the Trump paradox, which has it that the only thing that is predictable is his unpredictability. Maybe some of that is needed in order to break the logjam of geopolitical and globalised economic complacency. Is it not also frequently argued that Brexit will most probably lead to the reforms of the EU being instituted, the absence of which led the British people voting to leave in the first place?

Perhaps the Tomahawk missile attacks on al-Shayrat airbase will mark the beginning of a rethink well beyond Middle Eastern politics and lead economists and financiers alike to shine a new light on the debt-infested economic model that we are living with and ask how a better way of managing it might be found. Whatever they might come up with, it will have to include the observation that you can’t make an omelette without breaking eggs and that a decade of doing so has not improved the underlying.

PARADIGMS

In a conversation I had with an industrialist recently he proudly announced that his sector had found a wonderful way of creating a product that used less power and which lasted much longer than the same products of previous cycles. He then went on to whisper under his breath that having kicked its own stool out from under itself, his industry was desperately scrambling about for something new to get consumers spending money again which they no longer had to do with the longer life-cycle output.

Over the past 10 years we have often spoken or written about paradigm shifts. There has been a lot of tinkering but, to be fair, nothing has fundamentally changed in the financial model. The conundrum facing the monetary authorities when it comes to reversing QE and ZIRP is not a very well guarded secret.

Let us be clear, Trump is not a warmonger. What he has done, however, is to tear up the cobweb-covered diplomatic rulebook and my guess is that, despite all the noise, the threat of thermo-nuclear war is more likely to be diminishing that increasing.

Maybe ripping up Dodd-Frank will do the same. Could securitisation turn out to be the debt markets’ Syria? Is our boat about to be rocked too? If so, and in a post Dodd-Frank environment, then equity pricing and credit pricing might suddenly find themselves inversely correlated. That would shake complacency to the bone.

Have a good week.