Blain’s Morning Porridge, 26 Nov 2020 – The GFC 2007-2031

Blain’s Morning Porridge, 26 Nov 2020 – The GFC 2007-2031

“Just when you thought it was safe to get back in the water!”

Walking Home For Christmas Charity Appeal

Only two days to go before the first of three full-length hikes. On Saturday we will do 22km up three hills, Butser, Old Winchester and Beacon, on the South Downs Way. Still got a deal of money to raise!

This year I am joining my colleagues at Shard Capital to raise money for the UK ex-military charity Walking With The Wounded. The Charity supports ex-military and their families in need of urgent mental health care so they can thrive and contribute in their communities once more. This year our veterans faced the new battlefield of the Coronavirus and the mental challenges it raised for us all. 

She-Who-is-Mrs-Blain – my wife Nicky – and I are the bubblicious Team Morning Porridge. Get your wallets out and please consider making a donation to WWTW’s Walking Home For Christmas appeal! I would consider a small thanks for your daily Morning Porridge, but it’s a very worthwhile charity this difficult year:

Meanwhile, back in the la la land of markets..

A short rant about how financial uncertainty will continue for years due to the consequences of the ongoing Global Financial Crisis that began in 2007. 

Thankfully we will get a respite from Americans today – they get the day off while we give thanks they are over there and not over here. The news Brexit talks are stalled over who owns a pilchard with its head on the north side of the Channel midline and its tail in the south …. well, things could get dramatically worse..

Or they might not… There is nothing that says Britain under Boris as a last minute deal..

In light of more important news yesterday, it’s worth starting with Lord Mervyn King’s contribution to monetary theory, carried in the FT this morning, equilibrating Central Banking with Maradona:

“Maradona ran 60 yards from inside his own half beating five players before placing the ball in the English goal. The truly remarkable thing, however, is that, Maradona ran virtually in a straight line. How can you beat five players by running in a straight line? The answer is that the English defenders reacted to what they expected Maradona to do. Because they expected Maradona to move either left or right, he was able to go straight on.

Monetary policy works in a similar way. Market interest rates react to what the central bank is expected to do. In recent years the Bank of England and other central banks have experienced periods in which they have been able to influence the path of the economy without making large moves in official interest rates. They headed in a straight line for their goals. How was that possible? Because financial markets did not expect interest rates to remain constant. They expected that rates would move either up or down. Those expectations were sufficient – at times – to stabilise private spending while official interest rates in fact moved very little.

How the world changes…

There is lots of earnest gabble on the wires this morning about how the appointment of Janet Yellen to run the US treasury will change the relationship between Central Banks and Government for ever, that the independence of central bankers may forever be tarnished/burnished.

The World will change. That is nailed on. It’s clear the great Global Financial Crisis of 2007-2031 is not nearly over.

The current Pandemic Crash of 2020-22 will prove deep and crushing, and is another spanner thrown into the creaking engine of western capitalism. Yesterday UK Chancellor Sunak did his Dr. Chris Whitty impersonation warning of 2.6 million unemployed if the economy behaves as expected. If we don’t all sacrifice Christmas it will be even higher! He pulled out some of the usual graphs to show everyone in the UK will have lost their jobs by mid-Feb unless we leave Granny on her own over the holiday…

Given the Government’s predilection for scaring the bejesus out of us – and sober macroeconomists who reckon unemployment may only hit 5.4% – it’s entirely possible the UK economy will cruise out of Covid in April; bruised, battered, dented but only in need of some basic body work.

Running an economy is not like balancing a household budget. It’s more like running a car – every so often something breaks and you need to fix it, whatever it takes and however much it costs.

Sometimes that means borrowing money. Government with monetary sovereignty have the ability to “borrow” as much money as they need, by printing it. The dangers of monetary expansion on confidence and inflation are widely cited by the market orthodoxy as deadly and dangerous. But we now live in a very different world…

To understand why, go back to the start of the crisis in 2007 when a couple of small structured bond funds wobbled, the first few pebbles rolling down the hill. These dislodged the larger stones that closed the money markets and triggered the panic and the run on names like Northern Crock which crushed bond market liquidity. Then the boulders started crashing down the hills as Bear then Lehman went to wall. AIG effectively failed, the western banking system stood on the brink of Armageddon.

Ah.. happy times…

Then a crack force of bankers, politicians and accountants reinvented finance in the same old way.. intervention. They applied sticky backed plastic, sealing wax and string to stabilise the mechanisms of finance, stopped markets collapsing, bailed out banks, restored liquidity, dropped interest rates and did all kinds of clever things like quantitative easing to keep the creaking global economy turning…

But there have been massive consequences… and these will likely be the theme of the second half of the GFC – which will impact us all in coming years.

How do you unwind the distortions of the last 12 years? These include the pernicious effects of ultra-low rates, the massive stagflation in financial assets (massively higher prices and minimal yields; lower yield for more risk) and the very real long-term disincentives of zero interest rates on growth, investment and business innovation and evolution.

In 2008 central banks saved capitalism by completely undermining it. The challenge is to restore it.

We also see behavioural effects that stem from the consequences of dealing with the crisis: when bonds return nothing, risks are so high, and conventional assets promise nothing, people start to believe in fantabulous perpetual motion machines that will deliver unreal returns – hence the stellar valuations of unicorns, imaginary crypto-treasure, and other mythical beats.

When returns are so low management goals change – which is why we’ve seen such a large portion of the last decade’s corporate profits squandered and companies leverage themselves up on debt – both done to finance stock buy backs pushing up managerial rewards. It has made good companies go bad – look at Boeing as the prime example of a firm that effectively destroyed itself from the top.

And then there is the fact that inflated financial assets put most of the central bank created wealth into the hands of a tiny number of asset owners – all that money that governments and central banks have been printing pushed up bond and equity prices, meaning it has gone straight into the hands of the already tremendously wealthy! While the middle classes and poor suffered austerity, the top one percent have become obscenely rich. No wonder concerns on wealth inequality has gone through the roof.

The challenge of the next 10-years will be unwinding all these effect. If you were to simply unwind QE and raise rates – the result will be the most utter and complete market wipe-out of all time. It will destroy investment savings, markets and collapse nations as confidence in fiat money and government debt evaporates.

Which is why markets believe central banks and governments will remain complicit together to keep markets stable – by more distortions, bail-outs, low rates and QE infinity. Great for markets? How long? Only in the short-term. Without the discipline of the invisible hand and ability of overlevered companies to fail, and the frisson that creates in opening new business niches for new nimbler companies, then economies will fall into the same kind of lethargy the globe experienced in the dark ages, when government-granted monopolies stuntified growth and invention. Which means the West falls and China wins.

Yep.. this Global Financial Crisis of 2007-2031 continues. How do we get out of this one?

Five Things to Read This Morning

FT – Europe’s finance sector hits “peak uncertainty” over Brexit

FT – What Mrs Watanabe can tell us about how to handle low returns

WSJ – EU Official Raises Vetting Concerns Over BlackRock Contract

BBerg – Swedes Lose Faith in “Herd Immunity” Strategy With Virus Rampant

BBerg – Trump’s Next Two Months of Mayhem

Out of time… and a nice peaceful day ahead… doing my day job and not being harassed by American’s about fraud and what a nasty man Trump is..

Bill Blain

Shard Capital