Tesco’s dilemma is our dilemma

The decision by Tesco’s, the UK’s largest supermarket, to pay a dividend despite taking money from the government’s business rates relief is raising eyebrows. There is something perverse about taking a subsidy and simultaneously paying out shareholders, it is held. I understand why people think this is wrong because it’s a particularly glaring example – but what is going on here is not unusual. It’s the fundamental problem of Capitalism as we know it.

More people work for supermarkets than work producing food – Tescos employs some 300,000 alone, the whole agricultural sector counts just under 500,000. Whose work causes food to appear on our tables in this system? It’s almost a nonsensical question. The system only works as a whole. The needs of the distributor shape the production process. Part of that whole is dividend payments. Yes some of the ultimate owners of Tescos are fat cat elite international citizen of nowhere private island types. But many more are pensioners. Those pensioners are relying on the income from dividends to buy the food that the farms produce and Tesco distributes. Moreover, everyone is relying on the banking system being able to track and honour the claims they have. If markets for financial assets seize up because companies aren’t allowed to pay dividends, banks won’t be able to sell assets to meet your need for cash. It’s arguable that Tesco is a special case but for the country as a whole it’s undeniable. People are relying on the promises of financial assets to eat.

Capitalism in the 21st century is a very novel kind of system. In the UK, 1 in 8 working age adults work in production. Another 5 in 8 do service work, and 2 in 8 do not work. At this point in time, the people who make up those statistics are all alive, fed, housed, clothed and supplied with myriad goods. So are their children, and elderly relatives. The arrangements for this rely on the honoring of obligations. The kicker is it’s not possible to separate the just from the unjust, or the necessary from the frivolous. Capitalism as it stands ruthlessly separates the performance of meaningful work, the source of obligations and the actual production of things we need. There’s no way to discriminate between payments to pensioners and to offshore trusts in the Cayman islands. For our food distribution, we rely on organisations whose goals are not the distribution of food, but the distribution of money to shareholders.

The policy response needs to recognise this reality and actively seek to ensure that peoples needs are met. There are myriad ways to do this using the power of the state. Unfortunately, Capitalist ideology gets in the way. The assumption is that if a dollar is changing hands, a need is being met – and so the priority is to keep dollars changing hands without a thought for the production process. Glib calls for more PPE for NHS workers ignore the reality that no amount of money or willpower can cause these things to exist. They must be produced. The state could decide to top up pensions rather than subsidise companies dividend payments, but that would require an awareness of the purpose and distribution of income. Such awareness would of course preclude one from being a member of the present UK government. With the ideological blinkers on, tesco needs to pay its dividend and the show must go on.


My base case

This series of posts will serve as my personal record of what I expect to prove the most important monetary and economic phenomenon in decades. I don’t expect to be able to predict its course, but if I’m going to improve my understanding I need an honest record.

Firstly, I need to be upfront about what I’m trying to predict. The model I wish to test is for predicting and understanding balance sheet contraction events. Ray Dalio calls them “big debt crises” but I think debt is too narrow a scope. Balance sheets extend beyond that which you can tot up in excel – and includes family planning, system resilience etc.

My model is essentially Minsky with added Marxism. Minsky posited that stability breeds instability in financial systems, because balance sheets expand in stable times to the point where a crisis of confidence can take root. Marx frames history as a struggle between classes, of Labour vs Capital/Rentiers. My analysis of balance sheet contractions starts by looking at sectoral balance between Capital, Labour and the institutions between them – banks, firms and governments. Marx adds fuel to Minsky’s process by pointing out that capital owners pursue collectively self destructive accumulation and exploitation that decreases resilience and expands balance sheets. They also attempt to capture Government and use it to accumulate and exploit more. This leads to fragilities, whether financial or social. Capitalism has denuded communities, families, firms and the natural world of its capacity to absorb shocks in service of ever more accumulation.

I’m agnostic as to the proximate causes of balance sheet contractions. Rather the point is to understand how the dominos are stacked and where they’ll fall. Therefore, my day to day monitoring of the economy for vulnerability focuses on how balance sheets are before a shock hits. In the US for example, I’ve been monitoring firms increasing levels of debt with concern. Corporate debt in the US is at all time highs relative to GDP. This means that, all other things being equal, US firms are more vulnerable than ever to shocks that temporarily impair their ability to repay. Of course, all other things are not equal and I try to pay attention to as many of them as possible also. High corporate debt currently coexists with large cash holdings of the biggest US firms, implying that the most vulnerable firms are the medium sized ones. Many US firms are owned by private equity firms that have cash to deploy, and so may be less vulnerable as they have more of a cash buffer than their accounts suggest, even if private equity owners loading firms with debt is one of the main causes of the record high levels of debt to GDP. On balance, if the shock from Covid19 is going to propagate, I expect it to come from this sector.

As such, I’ll be watching carefully for signs that US firms are going under or cutting output. Here, I’m looking for the mechanism identified by Keynes and Kalecki. Balance sheet contractions propagate through the economy in a vicious cycle because everyone’s income is another person or firm’s expenditure, so if firms cut production they cut their purchases of inputs of other firms and labour. In normal times people and firms can use their savings, or borrow to cover a temporary drop in income – but if balance sheets are contracting across the economy or the drop is perceived to be permanent they hoard cash and cut their own expenditures instead. The shutdown of the US economy is so comprehensive and open ended that I believe this will happen.

Keynes thought that if the financial system generated a balance sheet contraction across the economy then the government should step in to replace the missing spending, but he wasn’t talking about a addressing a deliberate freeze in economic activity. The US government has cut firms revenues by decree, and wants them to stay cut until the pandemic abates. The missing spending cannot be replaced because its forbidden. As such, the massive government spending programs announced in the US and asset purchases by the Fed can only keep firms from having to declare bankruptcy while the economy is frozen, economic activity will fall to a “pandemic” level and recover slowly unless further dramatic spending rises are announced when the pandemic is over.

The shape of this downturn then is determined by three factors. First, how much capacity is lost to firms disappearing and their productive capacity destroyed or furloughed. Second, how much and how effective is government spending when the pandemic wanes. And of course third, how long the pandemic goes on. The third is the least economically interesting and I have no edge in predicting it. The experience of spanish flu implies 6-9 months is a reasonable timescale. The second is a matter of politics and ideology and there I’m not hopeful. A V shaped recovery would require global, coordinated and direct money payments to consumers to bring furloughed capacity back into use. I find it hard to imagine though I’m happy to be proved wrong. The first is the most important question that I can monitor right away.

This is how I’ll be spending my time over the next few months. How many firms are going bankrupt, and what is happening to their productive assets. Mothballed? sold on? converted to other less or more productive uses? Anecdotally, US oil producers will need to start shutting down wells this week as there is no more storage capacity. Restarting those wells will be expensive or impossible. Will retailer and restaurant firms try to put themselves on ice and re-open later, or will their owners simply strip them of cash and let them go under. The answers will determine how much productive capacity there will be to attempt to bring back into service at the end of all this. As I sit here having done no work on this question, it seems plausible that 5-10% of productive capacity will be lost to firms defaulting and leaving their assets idle.

This would be an economic catastrophe. There will be immense suffering if this comes to pass. It would not however justify the extent of the stock market selloff as it stands, especially as the most likely firms to go under are medium sized ones not included in stock indexes. My base case then is that stock prices will recover once the balance sheet contraction is over. Whilst it’s ongoing, prices will stay low and go lower.

In Summary, my base case is:
– 6 months of balance sheet contraction where stocks do not rise
– 5-10% fall in output due to firm bankruptcies
– Asset prices to reflect a 5-10% fall in output, rather than the 20-30% they do now after the contraction is over


A nation never pays its debts

Progressives are loudly hoping that the present crisis and the massive government response finally kills the “how will we pay for it?” idiocy that poisons discussions of public policy. Focusing on getting the idea that a sovereign nation can’t run out of its own currency is a good strategy, especially as this clear message resonates with most people. But this insight is only good insofar as it can be applied. The operational reality of fiscal policy is that if you are a politician in the government of a modern state, you’ll need to borrow in order to spend in excess of receipts. There is nothing necessary about this, it is true because of convention, precedent, politics and ideology. Capitalism demands that the allocation of resources be determined by individuals buying power, and this demand has shaped our institutions. Government debt in its current form is the result.

It’s much more obvious why this is if we restate things in terms of obligations, and forget the money. When a government issues bonds, it’s effectively increasing its obligations. People already have many obligations to the government, so if there is perceived to be a balance, this won’t be a problem. In some sense it’s always been this way. Before government bonds and the modern financial system, kings had to hand out privileges to selected subjects to get people to obey them. The King then had obligations to defend his subjects from foreign interference, but of course back then only the landowning classes had any relationship to the state. Now we all do. A King might have a good sense of which of his nobles where chafing against their obligations, but a modern state interacting with millions of people via the financial system has to ask the market. That is the root of the connection between government debt and spending. A modern state issuing bonds is effectively ensuring that it will still command the confidence of its subjects.

The counterfactual is that governments simply gave money in any quantity to whoever asked for it – which is equivalent to the king promising everyone the rights to whatever they can claim. In such a situation, no one has any incentive to obey the king and anarchy reigns – the promises of the government are worth nothing as they’ve been exhausted. The modern analogy of course is hyperinflation. On the way to hyperinflation is the regular kind. Rising money prices reflect the promises of the state being worth less.

The time dimension of government borrowing is also crucial. When a bond is sold, the yield it attracts is a measure of expectations of future inflation. If a government is seen to be borrowing and spending without expanding the capacity of the state to meet future wants, it makes sense that yields should be high – ie money tomorrow is worth much less than money now.

Seen like this, the questions of how a state pays for things or how we’ll repay the national debt are revealed as meaningless. Debts owed by the government are obligations to its own people. They will never be repaid in full because the state will never cease to have obligations – unless of course it ceases to exist in which case repayment is meaningless. The issue with debt for governments is not how they pay it, but how it impacts them in the present. The current system hasn’t evolved so far from the relationship of a king with his barons, and so if a modern state wishes to use fiscal policy it must do so with the consent of the modern barons, the holders of financial assets. Their consent must be bought so long as Capitalist ideology, that ownership determines the allocation of resources, reigns.

There is nothing necessary about this. Just as increasing state capacity enabled governments to wrest control of the land from the barons, the same struggle is going on for capital. Government debt is being annulled by quantitative easing, and now in response to the Covid19 crisis so is private debt. These actions are totally unprecedented. Ideas about debt that hold now will be untenable after the next few years as we are forced to reshape and remove debt to suit the urgent purpose of recovering from a global pandemic. Hopefully we can consign worries about the national debt to the same dustbin as “how will we pay for it?”.


Stock markets are not ponzi schemes, they're far more serious

There’s a popular idea about the stock market that I expect to see a lot more of as asset prices fall due to the Coronavirus crisis. Not to mention the likely credit crisis that will follow it. Stock markets are said to be a ponzi scheme. Sometimes the language used is more conspiratorial, implying that the stock market or financial system in general is a con job designed to rip off gullible investors for the benefit of others. The way the argument is made focuses on the fact that in order to sell shares, you need to find a new buyer. You don’t go to Apple to get money for your Apple shares, you go to the market and find a buyer – ie a new investor. Because ponzi schemes share this feature of paying out existing investors using funds from new ones the skeptic says they are the same. Beyond that, the fact that stock prices move with supply and demand and not necessarily with fundamentals means that they cannot be trusted as a store of value.

Both of these claims have big problems. The nature of money is that it doesn’t hang around. In any scheme where multiple people contribute funds to an enterprise, organisation or scheme of any kind and others withdraw them, it can be said that the money of new investors is being used to repay old. If I lend my friend a note to buy a round of drinks, he’s not operating a ponzi scheme by virtue of not paying me back the same note tomorrow. The whole activity of investment meets the criteria of a ponzi scheme by this definition, because the point of investment is to use money to buy assets in some form – not to act as a store of money. It’s impossible to differentiate the stock market from pretty much any other form of economic activity by this criteria.

The second claim, that prices moving based on supply and demand makes the market somehow fraudulent, has a similar problem. Every market for every investment operates in the same way. Many people espousing these views prefer gold, property or sometimes farmland as these are asserted to be more tangible. The valuation of these things however is entirely determined by supply and demand. Were there no dollars to pay for an ounce of gold, the price of an ounce of gold would be zero. It could be argued that property and farmland offer the means to life and so have a kind of irreducible value, but the purchase of property is not a magic spell. It is a contract. The deed to a property guarantees the government’s help in enforcing the right to use it, that is all. A stock is the same kind of legal right. It guarantees the legal right of the holder to the benefits of the capital owned by the company that issued the share.

In the kind of thinking that labels stock markets a ponzi scheme there is a reluctance to engage seriously with the issue of what investing is. Investing has always been to acquire rights to income without toil, to make a living from the work of others. The returns from investing have always been paid out from others. A world where economic activity and exchange breaks down completely is not one where this is possible, regardless of which assets one buys.

Stock market skeptics point to events like 2001, 2008 and even 1929 as evidence that valuations change rapidly – but their explanation of fraud ignores the important economic lessons of those crises. In each case, lending and leverage created the conditions for stock markets and wider economic activity to suffer. Before 2001, it was tech companies borrowing large sums. Before 2008, households borrowed from banks. Before 1929, companies borrowed from banks and households borrowed from banks to invest in companies. In each case, borrowing grew unsustainable, and credit dried up as balance sheets became impaired. None of this was fraudulent, though much of it was unwise and all of it could have been prevented by appropriate policies. Those who label such crises evidence of fraud will never learn from them.

The claim that stock markets are mere ponzi schemes gets nowhere near the truth of their importance or their nature. Manias and panics in the markets can and do contribute to problems in people’s lives that dwarf the effects of ponzi schemes on every level. Bernie Madoff operated the largest ponzi in history running into a few tens of billions of dollars. In 2009, US nominal GDP was about 300 billion less than 2008. At the time, GDP was trending higher at around 500 billion per year. So, a financial crisis was worth almost a trillion dollars to society. Consider the suffering in that number compared to the losses of Madoff’s wealthy clients. That suffering was a result of failures of policy, not malevolence or greed. That difference alone is so crucial that it renders the comparison useless. Whether looking at the whole economy or your own portfolio, its best to see things for what they are.


Why I’m starting to buy stocks again

The onset of a global pandemic may not be the right time for this commentary. I have no intention of encouraging morbid thinking, profiteering, nor neglecting the needs of people affected. Everyone should attend to those first. If you’ve taken care of yourself and your loved ones in the present, you might wish to join me in thinking about the future.

This future remains a long way away, and when it arrives I’d like to be confident of steady income. That relies on being able to acquire claims on future income at good prices. The biggest risk for me is not that financial assets decrease in price, but increase before I can buy them. Since 2016 I’ve been running that risk. I wanted to own real assets instead and didn’t think the financial claims on companies profits that stocks represent were sound. Companies in the west seemed too indebted.Rather than borrow to build capacity, they bought back their own stock and the stock of other companies to create market power.

Since that time, the debt burden faced by the companies that make up the S&P 500 has increased dramatically. Corporate debt in the US seems at all time highs relative to income and profits. My central scenario is that the economic crisis caused by the pandemic leads to a wave of bankruptcies of US firms, which triggers a global contraction. Other countries are just as vulnerable.

And yet I’ve started to buy stocks. Why? Because I might be wrong. I would be a liar if I said that the past 4 years of price appreciation didn’t bother me. The extent to which the Trump administration’s policies supported stock prices was a surprise. It is possible for me to imagine a policy response that does the same thing. Central banks seem determined to give it a go – slashing rates and restarting asset purchase programs.

I may also be wrong about the extent and nature of corporate debt. Even if I am right, and levels of debt are very high, they may yet grow. They may be forgiven or otherwise commuted by government policy. The willingness of governments to focus their policy response to the crisis on companies and not people worries me morally. It also concerns me financially, if they succeed in putting the retirement assets I want beyond my reach.

My thinking as regards my investments has little to do with the crisis itself. It’s simply the wrong timescale. I’m looking to gradually build a portfolio that’ll serve me for decades. If the crisis goes on a long time and valuations go lower, I leave myself plenty of room to buy. But the connection between valuations of assets and the nature of the crisis is going to change, and change fast. The economic consequences are coming now regardless of how many people get sick. As my central concern is the indebtedness of companies I’ll be following credit events closely rather than worrying about the relationship between the virus and the market.

Finally, compared to other investments, equities look reasonable after this selloff. Fixed rate returns from government bonds are low. It’s true that the bonds themselves may appreciate further, and I anticipate they will, but the zero lower bound for interest rates is very relevant in the US and UK – which are very cash intensive. The use of physical cash makes the transmission of negative monetary policy rates difficult as negative rates cannot apply to it. So the upside is limited by the fact that rates can’t go much lower without reducing cash dependency will take time.  Credit is starting to look interesting but I would rather wait for the defaults I anticipate and then look for high quality companies struggling to raise money than take a flyer now. Property looks vulnerable to me, supported as it is by bank lending. Corporate defaults could impair banks’ ability to support current valuations.

With a decent option on the table and concerns about the policy response to the crisis ruining that option I’m starting to get involved. Buying stocks is not a prediction about the behaviour of future prices. It’s a response to the conditions I face, and think I’ll face in future. Yours will differ from mine. I judge that the risk of the policy response to this crisis pushing asset values higher outweighs the initial loss of capital I’ll take if my central scenario of corporate debt problems arrives. After a 30% selloff, it’s cheap enough for me. Is it cheap enough for you?


Where to look for the US recession

I wanted to quickly recap a conversation with a friend today about the US economy as his question was good and my answer was passable.

The story so far is that, after initial reluctance to tighten policy, a combination of Fed rate hikes and increasingly stringent bank regulation in 2018 caused a marked monetary tightening in the US. At the same time, US foreign policy began to have the explicit objective of reducing trade. In the meantime, steadily since the GFC, US companies have been shouldering increasing amounts of debt – reaching new highs in terms of corporate debt/nominal gdp:

We might therefore expect problems to begin in the corporate sector as financial conditions tighten and at the same time, trade is stymied. And indeed, survey based measures of US firms confidence and business conditions are declining fast. My friends question was, how can we tell if this is spilling over into the wider economy and causing a recession.

In general, if you’ve got a factory or an office block you want to have it to do something – but what you can do as a firm is reduce investment. It happened two quarters ahead of the recession in 2008, and two quarters ahead of the slowdown in 2016.

This is the first place I look to see if firms balance sheet issues are going to spill into the economy. The latest data we have is Q2, which showed a 0.5% increase. That’s consistent with slowdown. A negative reading would mean it’s time to expect recession.

The second place is the overall wage bill. Whilst unemployment is bad its not recessionary, except insofar as the unemployed’s missing wages are seen as a lack of demand by firms – which cut output and investment in response. There’s probably a good time series for this but I couldn’t remember it, so I multiplied average hourly earnings by hours worked per worker by total non farm payrolls to get one.

The total wage bill has been growing with remarkable consistency at 1% per quarter since the global financial crisis. We have Q3 for this measure, and it looks like the dip in Q2 got corrected in Q3 – so I’m cautiously optimistic. Pre 2008, this measure spent 2 quarters below 1% before diving lower into the GFC itself. Note that in 2015/16, this measure would have told you neatly that the drop in investment wasn’t feeding through into incomes and thus leading to recession – it never really dipped.

If we think about a decline in confidence by firms leading to a reduction in investment, and that lower level of demand shrinking the wage bill causing a concrete lowering of final demand – we are already quite far along the chain of causality that causes a recession. During this process, further weak survey data tells us nothing – we already have our warning. Neither are we worried about inflation or changes in monetary conditions, which affect the economy with a big lag. I’ll thus be ignoring all that stuff until we get the signal that a recession may be coming confirmed in capex and then the wage bill. I humbly suggest that for the sake of your peace of mind, you do the same!


It’ll all end in tiers

Departing ECB president Mario Draghi announced this week that the ECB would henceforth use a tiered deposit rate as one of the main instruments of policy. I want to set out briefly the mechanics, and the implications of this move – which I agree with Eric Lonergan as he wrote here is a highly significant one. The short version of this post is that I think tiering will work, the money supply in Europe will grow rapidly, and I’m optimistic about a Eurozone economic recovery in 2020.

Firstly, the mechanics. What won’t change is that the ECB decides the quantity of reserves . They can increase it with further QE and TLTRO’s, or decrease it by letting bonds they hold mature or selling them back to the market. Under the old system, about 10% of these reserves were deemed “required” – and banks parking them at their national central banks could do so at 0%. That amount is calculated as a % of banks total customer deposits – around 1%. Eurozone M2 is about 12 trillion, so 120bio of required reserves. On that 120bio, the banks paid nothing – ie 0%. On the remaining 1trio, they paid 40bps – the deposit rate set by the ECB to try and “stimulate the economy”. This amounted to a tax on the banking system that went straight towards the ECB’s capital. A strange way to stimulate the economy…

This week’s decision means that banks will pay 50bp on around half of total reserves, but 0 on the other half – compared to 40bp on 90% and 0 on 10% before. Each bank can enjoy the higher tier rate on 6x its required reserves . This multiplier will become a policy instrument itself – and will be announced for each reserve period.

As I see it, there are three main implications in order of importance: firstly, saving 50bp on around 700bio of reserves means a tidy 3.5bio that banks save each year. KPMG reckons European banks net interest margin is about 1.2% of total bank assets, and ZEB reckons that bank assets are about 45trillion – so roughly 500bio of net interest margin. 3.5bio is a drop in the ocean, if a welcome one. Secondly and much more importantly, banks as a whole will benefit from expanding their net lending to non banks. This net lending is what causes total deposits in the banking system to increase – and increasing total deposits is the way to increase the “required reserves” that are subject to the relief rate.

Pretty much every policy implemented since the GFC has made it harder for banks to lend to non banks. International rules on capital requirements have increase the cost of adding a unit of balance sheet. Liquidity requirements have forced bank ALMs to scramble for increasingly scarce short term paper. QE has increased bank reserves at the expense of safe term assets (government bonds) that banks can hold, and by pushing up prices reduced the net interest income of holding them. Sure the interbank lending market is flush with funds, but these are bank reserves that can’t escape into the wider economy – only banks balance sheets can transmit monetary policy – a point Mario Draghi was at pains to make during the press conference and about which he is absolutely bang on. This policy represents an accurate understanding of the problem of transmitting policy and a commitment to solve it.

The most important thing that tiering does though, at least in my book, is open up a whole suite of tools that the ECB could use in future to influence the behaviour of banks. They can fiddle with the multiplier, initially set at 6x, to change the incentives for the banking system overall to create more deposits – but that’s the least of it. Relief on tiering could be linked to new consumer lending, or new business lending – with a banks YoY increase in lending being an additional source of relief. By giving themselves a tool to impact the marginal cost of providing credit, the ECB are taking back a large measure of control.

Some think that it’s small potatoes and just a way to stop banks complaining about the penalty rate. We’ll see. I predict that Eurosystem leverage is going to increase markedly – and we’ll see substantial M2 growth. Check back here in a year for the Mea Culpa if I’m wrong! Good luck out there.


The view from Singapore

And so, after four months of enforced idleness thanks to the vengeful nature of my former employer – I’m back in a chair, poring over my screens to once again try and make sense of the world. I’ve been fortunate enough to move to Singapore, and if any readers know smart, curious and friendly folks out here I should be connecting with please do take the time to tell me who they are. A couple of weeks back I wrote a quick summary of how I thought things might have gone during my time off – and wanted to check back in to see how I did!

Firstly, what seems clear is that there is one main show in town. If one compares M3 growth to nominal GDP growth across the major economies, not one is growing faster than the 5y average. Global monetary conditions are tightening across the board. The biggest deflators, relatively, are the US and Australia. Both have money growth slower than NGDP growth – so are tightening both relatively and absolutely. My first expectation was that the market would be anticipating the Fed tightening to the point of recession, but despite the selloff in equity markets in october – the picture post mid terms is much rosier than I expected in the market’s collective mind. The curve is steeper – implying a more orderly tightening. Equity markets are recovering, albeit not as quickly as many would like. However if you talk to people they will earnestly tell you they are expecting recession and slowdown in 2019/20 – and indeed some of the big american banks have made this call with JP Morgan calling for a recession in 2020. To me, the market seems ripe for this narrative to be picked up in the new year – and so the current pricing of interest rates seems far too agressive. The peak of the forwards curve is at 3.40 in the US and I would expect that to come down to just above 3% in an economically bearish scenario. The theatre of Democrats subpoenaing Trump acolytes left right and centre might provide a catalyst for that, as might the prospect of a government shutdown. Moderates did not do well in the mid terms – so Democrats ought to be spoiling for a budget fight.

The other big potential catalyst is Australia -where the combination of central bank complacency and housing market weakness remains a powerful driver. Still the most deflationary monetary environment in the developed markets, and with an outsized financial sector (40% of the stock market!) – Australia is the prime candidate for a financial market induced slowdown. US rates are probably the better play – and option structures that would do well from Australia => US contagion look more attractive than piling into the already well received Australian interest rate market to me. I think that broadly speaking I got this one right – and receivers of Australian rates have been well enough rewarded -especially if done vs USD.

As regards Europe, the view from this side of the world is cloudy. Spreads remain wide and every day brings news of further tensions between the Italian Government and the European institutions. However, all of this still looks to be a red herring. What matters is ECB policy – and no matter what constraints are there legally and practically to keeping an insolvent Italy in the zone through monetary chicanery – the baseline assumption has to be that the ECB will find a way. It is, institutionally, one of the worlds most independent and powerful central banks. In a fight between it and the current government, I would take the ECB every time.

FOR THE RATES MARKET PROS: A neat tactical play for near term worries is provided by a previous bit of ECB intervention. A large chunk of TLRTO money (loans the ECB made to eurozone banks at highly preferential rates) becomes too short for banks to rely on it to goose their NSFR (net stable funding ratios) in the new year – so they will either have to issue paper, borrow in wholesale markets, or the ECB will have to step up again. In its current hawkish messaging –  the latter is less likely.  Paying Bobl spreads here looks a good way to position for eurozone breakup fears and benefit from the coming rush of banks to the market. If anyone wants to tell me I’m wrong because of seasonality, or because the bobl future is too rich on the curve then I would love to hear it!

FOR THE NORMAL PEOPLE: The big story of global financial retrenchment is going to be the big story in 2019. Most people are carrying around a model in their heads that says that money was ample for the last 5 years but mysteriously the market didn’t respond. We know they’re wrong. Monetary aggregates have been growing at their normal pace – despite central bank action. The world has moved from a normal environment to a tight monetary environment – and that is going to be the backdrop for markets in 2019. Expect many surprising bearish events – from EM panics to esoteric parts of the developed financial markets blowing up – as $ become scarce everywhere.



What I expect

As I return to financial markets after a 4 month hiatus, I wanted to jot down what I believe to be true so I can compare with what turns out to be true once I sit down in the chair again. I’m sure thinking in many areas has moved on – and I don’t expect this to be right – but I  hope the ways its wrong are instructive, so here goes!

When I left – the US yield curve had already inverted. 3m rates in 2y time were below 3m rates in 1y time – meaning the market had started to price some probability of either Fed tightening or a reduction in nominal GDP growth following rate hikes. In other words, the Fed will tighten to the point of contraction. I don’t expect that belief to have changed in these four months. I’ve avoided most economic news – but the dribs and drabs that come through my twitter feed haven’t indicated the kind of barnstorming US growth that could perhaps change the markets mind on the appropriateness of hikes. I expect to sit down to an inverted forwards curve again, and to no change in the widespread belief that a recession or at least a slowdown is coming in 2019/20.

I expect there to have been bearish changes to the markets view on Italy due to looking ahead to succession at the top of the ECB. By now, a hawkish faction of believers are probably gaining ground and persuading some that ECB policy will become less accommodative with the departure of Draghi and that this will drive greater sovereign spreads. Whilst short term concerns about budget deficits and other faffery may be dominating the headlines – the smart money will have maintained the view that ECB policy is the only meaningful driver of sovereign spreads and will be reluctant to lean against the widening.

The situation in Australia should look quite similar – but I would hope that some have started to see the issues there, with the big contraction in broad money growth that started in late 2017. Unless this has reversed due to unforseen changes to bank lending policy – I would expect that Australian growth is anemic with wages and prices exhibiting decent growth – and there is some hand wringing about the fact that inflation is implying hikes whilst the “tone” of the economy argues for cuts. The RBA appears quite complacent to the decline in broad money – focusing on CPI and the mortgage market – so I would expect the opportunity to receive Australian rates to be in place still.

Let’s see what happens when I turn on my Bloomberg and have a look around at the playing field next week !


Managing Capitalism

Today finds me, dear readers, in a particularly good mood! Having spent a good number of happy years on the dealing floor of a big bank, I’m heading to another one, and relishing the prospect of several months gardening leave. This is one of the more pleasant side effects of working for gigantic, bureaucratic, paranoid institutions staffed by the risk averse. Despite my general goodwill towards all, my former employer’s paranoia that I would steal clients/knowledge/whatever else forces them to effectively pay me to sit here blogging about my ongoing battle with capitalism rather than working out my notice period. Naturally, they are doing their best to withhold any salary they can , but I’ve no ill will towards them on that score – after all they are responsible to their shareholders. As I leave the firm, I wanted to offer some reflections. People often ask me what it’s like for someone “like me” working for a bank, and it has been interesting! But more than that, I have some recommendations for those who struggle with working under capitalism on how to manage it from a personal perspective. I hope you find them useful!

For starters, I’ve always cast my working life not as a “career” but as a constant negotiation with capital. My starting point is that any employer, being an agent of capitals interests, will be out to get as much possible value from my effort as they can, and share as little of the monetary value of that effort as they can with me. This is not a matter of them being evil and me being righteous, it’s simply a fact of the kinds of institutions that dominate our economic world. As such, I resolved very early on, that I would only make such efforts as I knew would either satisfy me personally, or get me paid better. In my thinking, there is no place for sucking up to ones boss, spending late nights at the office, or other such display activities. I expect to be paid my replacement cost, discounted by the likelihood of my finding alternative employment. At the start of my career, there were few vacancies and many unemployed market makers – so being paid a steep discount to my replacement cost was expected, and I took that wage with no hard feelings whilst my colleagues groused endlessly. One thing that’s amazed me throughout my career is the extent to which capitalist ideology makes my colleagues shocked, SHOCKED!, to discover that they are exploited by the firms they work for. The amount of times I was told “I worked so hard, I DESERVED to get paid this year!” – as though that should have anything to do with it – was bizarre. Perhaps there is a premium to be gained by signalling unhappiness to ones management, though I’ve not seen much evidence for this. What I have seen is the toxic effects on individuals mindset and life satisfaction from really being unhappy. It is a tragic waste. Recognising the reality of the relationship one has with an employer, that they are engaged in exploiting your labour, is very freeing on a personal level.

This is not to say that one should not negotiate aggressively with ones employer, or be satisfied with less. I would always counsel people to stick up for themselves. One of the favorite methods that managers, acting out their role as enforcers for the interests of capitalists, like to use is to appeal to employees decency. The sad reality of such an approach is that the manager and the employee are ALSO having a real relationship, alongside the role that the manager is playing. In my experience, good managers understand this and are open and honest about the role they play in order to be able to also have a real relationship. That takes emotional intelligence, empathy and integrity – attributes sadly lacking in the investment banking world, but luckily so valuable that those who exhibit them can and do succeed wildly. Managers who don’t separate the two, which is most, end up poisoning their relationships with employees by mixing roles and including the demands of capital in their social discourse with employees. That sucks both for the employees and the manager, unnecessarily making both miserable. The method that I’ve found that consistently works is to force an understanding of the separation of roles as quickly as possible. It may sound hard, but telling your manager “I expect to be paid my replacement cost and will act accordingly, I am not relying on your goodwill” is an honest and useful thing. This was a conversation I had early on with the boss that I am quitting on, and straightened our relationship out very well. Of our team, I was the only one they did not undermine or bully – because they understood that my self esteem and expected compensation was not tied to their approval. This was a very valuable experience for me, as it’s the first time for a few years I’ve had a ‘bad’ manager and so needed to implement my theory about how to deal with it and it worked well.

I put bad in inverted commas, because the skills that are required to manage well are in short supply. I do not begrudge any individual with a lack of emotional intelligence or empathy, such a person could and should be valuable and useful if working with sympathetic people in a framework of honesty and trust. Unfortunately, creating such conditions under capitalism is not easy!  Still, we must try. I don’t mind sharing that the initial shock of the conditions at my previous employer caused me serious problems. For a while, I felt quite confused – believing that I was merely struggling to adjust to a new city and situation and it would right itself. Depression, anger and self destructive behaviour followed. Mercifully not for long. Upon realising that something was deeply wrong in my work environment, I resolved to try and do something constructive about it. My efforts were mostly unsuccessful. I like to think that there are some deep cultural problems that there was no chance I could make a dent in, perhaps I am just not that good at creating a positive environment for my colleagues. Either way, my situation improved enormously simply through making the attempt. I felt purposeful and empowered. Being generous and attempting to manage the shortcomings of the environment put me in a position of power. When I saw my efforts making little impact, I was lucky enough to have other sources of self worth to say “ok, no hard feelings, time to go”.

The one key advantage I feel I’ve enjoyed through all of the trials and tribulations that a job on the dealing floor of a big bank brings is that I don’t accept the legitimacy of capitalist relations. I accept that in my own interest, it is often sensible to do what I’m asked by my managers. It’s even sensible to make strenuous efforts whilst working in a capitalist system – so long as those efforts are compensated. Making these efforts can even be pleasant! Being part of an institution with vast amounts of intellectual and human capital allows one to develop ones own capabilities. If others benefit from the value I create, that is fine by me. The world is very much not a zero sum game. What is not good is selling oneself short to satisfy the illegitimate demands of capitalism. It is not your duty to create value for others. It should be a happy side effect of cooperation. None of this is easy. Capitalism creates and perpetuates exploitation on a very personal level. Bullying often gets results, as does manipulation and dishonesty. As soon as one sees this for what it is, it loses its sting. As I enjoy some months to sit and reflect, I intend to write more on how resistance to capitalism on a personal level can be a route to personal and professional fulfillment – and I hope for at least some, it will be uplifting and useful!