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Central Banks Exacerbate Economic Imbalances

Central Banks Exacerbate Economic Imbalances 

Government control is becoming increasingly absolute,  moving the economy away from the productively optimal  level to its own view of the world. Imbalances are piling on  at every level to pay for this, borrowing growth and now  output from the future.  

Beyond direct government spending, the ECB, for example, sets the price of money, around which all other prices and  volumes are determined, and, through its balance sheet,  controls 53% of M3 money supply. It determines what  banks can hold as capital, directing money into funding  government borrowing, and, through reducing the  regulatory risk weightings of relevant assets, it is set to  steer an increasing proportion of bank and insurance funds  into renewables, which, given they are uneconomic, will  require further base monetary expansion or increasingly  negative rates and government control to underwrite.  

Through raising asset prices relative to GDP, the government  has raised the age at which the young can afford a house,  pushing back when they can marry and have children, reducing fertility rates and altering the demographic.  

Until the system clears, which I believe we are still a long  way from, the economic and social distortions, and the  imbalances and cost supporting them, are going to  become much more extreme. Real yields will become  increasingly –‘ve with base monetary expansion bridging  the gap to more unproductive spending and output.

As highlighted in Hiding the Imbalances in Plain Sight, the reforms of the late 1970’s and early  80’s, which lifted U.S. real yields (10-year Treasury discounted by the spot PCE deflator) from  a low of -292bpts in February 1975 to +935bpts in June 1984, reshaped the world economy.  

The reforms were mainly in the private sector, preventing strikes, and Paul Volcker’s raising  of interest rates to target and price out zombie production and thereby lower the effective  cost of capital to the remaining productive players. This allowed the development of North  Sea oil, for example, reducing the Middle East’s share of world oil production from about  37% in the mid-1970s, when it held the world hostage, to just 18% by 1985. 

By restructuring  the domestic economies, it also forced change at an international level, famously breaking  the command economy of the Soviet Union by outcompeting it, opening its markets and  labour to be developed and used more productively. Similarly, it raised the economic and  political cost of the Chinese Communist Party, whose control started to be eased, opening  the country up to subsequent growth. 

Unfortunately, from the high real yield point in 1984, rather than pressing on with the restructuring, policy was quickly relaxed. 

The Plaza Accord devalued the dollar 40%, Reagan and Clinton dismantled the anti-monopoly laws, and  through his change of trade policies, Clinton opened the door to global monopolies, often  with state backing, while Greenspan and his successors lowered interest rates to carry the  growing imbalances, with the result that U.S. 10-year real yields are rapidly approaching the  1975 low. 

The Middle East’s share of oil production has steadily climbed back to an average  of 33% over the past 5 years, and I would argue is set to move significantly higher. Viewed in  this light, the recovery in real yields in the late 1970s and early 1980s was a cyclical  correction in a much bigger structural decline, which becomes obvious when you realise  that the system of unlimited government is the imbalance that must be cleared, which  instead, has been growing all around the world.

The U.S. Ten-year real yield, discounted by the spot PCE deflator, was recently -236bpts, the  worst since mid-1975. The index linked real yield, which discounts the nominal yield by the  bond market’s own 10-year inflation expectation, was a record low -122bpts. U.S. debt and broader measures of liabilities (or assets) are at the highest level relative to GDP since Bloomberg records began in 1947. Federal debt relative to GDP is the highest since WWII,  and based on U.S. Congressional Budget projections, set to reach new record highs over the  next few years, and unsurprisingly, other than a peak in WWII, U.S. total government  spending is a record percentage of GDP. U.S. inequality is also the highest since the 1920’s, not only reflecting the unproductive allocation of capital, but also, as one would expect  because of the accounting identity, causing it. 

World energy production growth is the slowest since records began in 1900, worse even than the 20’s and 30’s, indicating that any economic  growth beyond that is from degrading the internal energy gradient, such as from the aging  of capital stock, and is therefore unsustainable. Whichever indicator you look at, the  imbalances or unproductive allocation of capital relative to GDP, and the government  control driving and sustaining those imbalances, are at or towards extremes. 

This means  that the economic, social, political and geopolitical risks are also towards highs, and based  on record unfunded liabilities, a deteriorating demographic, the commitment to  renewable energy policies and the prospect of peak oil, are set to get a lot worse. The  positive is that once the system does eventually clear, there should be an “economic miracle'' similar to after WWII as prices are allowed to find their own levels, shifting from government  dictate of what something is worth to productively optimal levels, but this can only happen  once the imbalances are cleared. 

 

In the late 1970’s and early 80’s, faced with negative real yields and the economic weakness that resulted, Volcker could have cut rates to soften the immediate blow from high oil  prices and the consequent negative real yields, thereby supporting the imbalances at the expense of the productive economy. Instead, with the Fed’s new inflation mandate, he chose to raise rates, thereby focussing the economic damage on the imbalances. 

Whilst I would argue we are in a bad or worse position today than back then, the Fed is far more  likely to cut rates over the medium term rather than raise them, adding to the imbalances  rather than clearing the system of them. This will be both at a domestic level, but also at  an international level. I would further argue that, as the power is in the hands of the asset  rich, they will use that power in support of themselves via further asset price inflation, and  concentration of that wealth and power, which will mean taking interest rates negative.  

Just as Nixon was not going to be held back by Bretton Woods and the discipline the gold linked standard provided, neither will today’s government be held back by the zero bound, which will become circumvented by digitising the official currency.  

At a system level, all inputs and outputs are an identity. This means that the cost of  production is equal to the value of what is produced. Allocating capital otherwise, such as for  “social justice” reasons, will always be at the expense of reduced capital and lower GDP. By  taking capital away from where it is produced and deploying it unproductively, it is a path to  the lowest common denominator. It takes away from individuals their property rights,  including their personal God-given gifts and individuality that they were endowed with, which is unforgivable, and by destroying capital and lowering productivity, it also takes away  from society as a whole, making the world a much less rich place in all senses of the word. A monopolist’s profits are defined as revenues paid to factors of production in excess of the  productivity they are generating, the perfect definition of the misallocation of capital. 

This same definition would also apply to government policies that, directly or indirectly, move  production and consumption away from where it is produced, and therefore away from  where it would optimise productivity and utility. This is to be expected as the only reason  for unlimited government is to allocate capital other than how it would optimally be produced, making it the ultimate monopoly. Whilst policy objectives may be to offset other  unproductive and therefore unsustainable allocations of capital, as they can only be the result of a managed system, rather than government policies clearing the imbalances, they  carry them.  

Creating an unproductive dependency between the government and the electorate, the  policies can only be sustained by adding more imbalances, and more control. 

By taking capital from a productive part of the economy to finance unproductive spending, the government creates a secondary imbalance where it has taken the capital from, as, without  it, maintaining its production is dependent on extracting capital from another part of the economy in what is called the Road to Serfdom. 

The time delay between the capital being taken  and the output falling is because we immediately revert to consuming down any reserves of  capital, shifting from degrading the external energy gradient to the internal one. This can either be specific to the place where the capital has been taken from, or more likely from the broader economy as the system optimises within the new constraints, by changing the terms  and quantities of trade. This creates a positive cash flow from, for example, underinvestment  and letting the remaining capital age further, until eventually the cost of additional  maintenance exceeds the value of what is produced, at which stage the maintenance can no  longer be afforded and output falls. 

The loss of capital is cumulative, with its growth initially decelerating, represented by positive but falling real yields, then the stock of capital peaking as the real yields fall to zero, and finally the loss of capital accelerating as the real return on  capital goes increasingly negative. The cash flow that is released from the increase in debt  relative to GDP is at the expense of future output, either lower growth if the real yields are  positive, or a sharper fall in GDP if the real yields are negative. 

This also means all outstanding imbalances are dependent on the next imbalance, including more extreme leaders, without which they would all clear in a catastrophic event. The only way to sustain them is with more imbalances, so if you cleared the system of 10% of the imbalances, the remaining 90% would be dependent on starting the process again, in a system of self-dependency, explaining  much of the history of the 20th Century from the formation of the Fed onwards, and indeed  to a lesser extent, going back further. This means that the government’s role should be limited to codifying the natural law into written law, and that any other role should be done  by the market optimising the allocation of capital. It is only through zero government,  removing its “truths'', or distortions to fundamental values, that we can understand that government is the problem. 

Unfortunately, until we have such a system, the unproductive  society will only tolerate politicians such as Margaret Thatcher and military generals such as George Patton for a very limited time to do the minimum that is necessary before it turns its  backs on them, because to reward them otherwise would be to reject the unproductive  society of which we are all part, highlighting the dilemma we are in. 

Catastrophe theory  explains how small changes in certain parameters of non-linear systems can cause  equilibria to disappear, with forces that were attracting now repelling and vice versa,  leading to large and sudden changes of the behaviour of the system, which is why a lot of  the big clearing events in the past are from the system falling of its own weight or from an external body forcing the clearing such as through a war, or with global imbalances, a world war. 

Whilst these events can appear to come out of the blue, catastrophe theory reveals  that such bifurcation events tend to occur as part of well-defined qualitative geometrical  structures. To this end, it is worth remembering that the 5th energy law means that the most  productive economic and societal structure is a natural hierarchy or trophic pyramid, and  therefore movements away from that will create points of stress, which if one breaks, could  mean the whole system is unable to sustain itself and implodes. 

As the distribution of wealth and power has become defined by the unproductive  allocation of capital, it means that those with the wealth and power are the imbalances, and accordingly, that we are being governed by the imbalances, although it should be made  clear that these people don’t generally understand that they are the problem, instead  believing that they are doing what is best. The only way for them to prevent the system clearing, and thereby maintain that unproductive wealth and power, which is not creating  the utility to pay for itself, is by taking more control by adding more imbalances and destroying more capital. 

This would also mean concentrating the wealth and power in fewer and fewer hands, so a growing inequality not just between the top 1% and the rest of society, but within that 1%. It would also mean moving money and assets further away from productively optimal values and mixes, destroying capital and reducing the number of  competing products and assets. 

Most obviously this means value stocks underperforming,  even as the parameters that define them as value change with time. It also means that things like gold, which one would expect to outperform if the system were to be cleared of the fiat imbalances back to a more productive monetary system, and thereby a more productive distribution of that money and power, will continue to underperform until nearer that eventual clearing event, when the movement would be exponential. Lower interest rates can only support an increase in debt relative to the GDP backing it by reducing capital. 

This means less competition, thereby not only concentrating wealth and  power in fewer hands but also in fewer assets, companies, and products etc. To prevent  the system clearing and adding to the imbalances, the wealth and power must concentrate  into fewer hands, and in so doing, into fewer instruments and products, and importantly, fewer productive ideas, and less knowledge. 

Expect more M&A, share buybacks and an  increased concentration of global capex in fewer firms. In order to concentrate the power  into fewer hands and fewer products, those with the power, and what they are willing to do  with it, must become more extreme, as must the tools or products they use to do that.  Through monetary, fiscal, and regulatory policy, and through its more extreme  interpretation, the government will shape the economy to that end, which inadvertently, will lead us in one direction.  

Unwinding the imbalances would necessarily mean taking power away from the asset rich,  explaining their hostility to the challenge from Brexit and Trump, and the apparent divide  between the political class and the workers. Whilst superficially the ruling elite were  defeated, as both Boris Johnson and Donald Trump largely continued the policies of bigger  government, the imbalances continued to grow, just in a slightly different way. Neither figurehead, nor I believe the movements they represented, understood the reason for the social  and economic pain, and therefore their solutions were, at best, insufficient, and with the  government trying to manage any pain from them, added to the imbalances rather than  clearing them. 

They were just a continuation of the decline. Nevertheless, the scale of attack against Brexit and Trump, and the defiance of the political class to the will of the people, gave a small clue of what is at stake, of what the cost of sustaining the imbalances will be in terms of increased government control, and what the eventual cost of clearing of them will be. 

This has obviously been taken another stage further with the lockdowns and removal of free speech on the back of COVID, but as one would expect, along with that increased  control has come increased risk as the policies, and politicians behind them, become more extreme. 

Whilst no one wants to hear this, it is to be expected as the imbalances compound,  and therefore the forces from those imbalances trying to clear, and from the government  adding more imbalances to prevent that clearing, will become increasingly extreme, as  history attests.  

The imbalances are at every level, including at a global level. All systems self-order to  optimise the degradation of the energy gradient within its boundaries or constraints, which in the economy and society’s case, are largely the government and central bank policies. 

Over recent decades, these have resulted in the imbalance most obviously being in asset price inflation relative to the GDP that is backing it, shifting the wealth and power from a  productively optimal distribution of workers, entrepreneurs, and owners of capital, to  concentrating the power in the asset rich. It has also shifted production abroad, making some  of the imbalances global, which, given that we are defined and governed by the imbalances,  has given the impression of a global government or “Davos Man”, especially from the  international conglomerates that seem to stand outside or above the national level. 

Ultimately, however, the power still rests with the sovereign, for the time being at least,  and at a higher level, the people, but importantly, they need to remember that and start exercising that power. 

This means re-engaging with the political process, defining the political parties which have become totally divorced from the public they are supposed to represent. Whilst the public could take back power whenever it wants, simply by withdrawing its collective labour or consumption, as it would come at a huge expense, it will only do so  when the costs of not doing so are high enough to make it worthwhile. 

Until it does, the inflation will remain largely focussed on asset prices rather than end goods. In this sense, we  can see the end goods inflation of recent months as an “investment” in this trade. By closing the economy and paying people not to work, the government bought the public’s support,  but in doing so destroyed capital, reducing productivity and therefore real GDP. 

Whilst some of that loss was through damaged supply lines and reduced inventory resulting in end goods  inflation, as the record wealth relative to GDP attests, most of it has been in asset prices as  investment, competition, small businesses, and productive jobs, and competing ideas and  opinions, were the real sacrifices. Recent data showing record inflows into equity funds  whilst monetary growth aggregates slow suggest a continuation of this trend.  

Whilst there are imbalances at every level, from within society to the global level, all of which  are points of risk, it is the overall control that must grow to prevent the system clearing. This  means individual risks will go in and out of fashion depending on the government or  economics of the day, but overall the imbalances, and therefore risks, must continue to grow.  

Many people believe that inflation will rotate to end goods rather than remain in assets, which is certainly possible, but it would mean taking power away from those that have it, who would use all their tools such as media, lobbying, and taking capital and jobs out of the country to oppose such a move. Shifting the focus of the imbalances would also change relative imbalances, which would add to risks, and change counterparties to those risks,  although that may be necessary to avoid the system clearing. 

Ceasing trade with China, for  example, would create a massive imbalance between its capital stock and consumption, unless another trading partner, or other use could be found to balance that, would  inevitably collapse the economy and turn the public against the government. 

Whilst similar damage would be done in the U.S. This highlights the risks of changing the terms of trade too abruptly, potentially resulting in the system clearing, which is why the government is not going to voluntarily make the change. Trump did obviously impose tariffs and China adopted its “dual circulation” policy which is creating stresses between both counterparts but are only moving the imbalances in a different direction rather than clearing them. It should be remembered, however, that every time a new imbalance is created, it will change the  economics of all production, and therefore of all economic and social relationships, or  “terms of trade”, so the risks mount up just carrying on in the same direction. 

People also believe that end goods inflation would clear the system, but as inflation is always monetary,  and more specifically, monetary growth in excess of the productive demand for money, whilst it would change the location of the imbalances, it would still add to them rather than  clearing the system of them. The only way this would not happen is if the money within assets  rotated back to end goods in more productive ratios, i.e. the system cleared, which can only  happen if the price and quantity of money were cleared of government control and started  to be priced productively, which is a long way from happening. 

Although a rotation into end  goods inflation could easily be engineered, a productive rebalancing cannot happen if money  supply is expanded faster than the productive demand for money, as it would add to the  imbalances. 

Instead, the central bank is likely to take more control through central bank digital currencies and the “full money” systems they would inevitably lead to. The imbalances are in the real economy, and just changing how they reflect in the nominal economy, from  assets to end goods, does not alter that they remain unable to create the real return to  finance themselves and are therefore at the expense of capital destruction, and reduced  real GDP. This doesn’t take away from the fact that, to prevent the system clearing, the central bank must continue to either lower interest rates, or keep expanding base money supply, which inevitably means moving towards a “full money” system. 

The ECB already sets  the price of money, around which all other prices and volumes are determined, and,  through its balance sheet, controls 53% of M3 money supply. It determines what banks can  hold as capital, directing money into funding government borrowing, and, presumably  through reducing the regulatory risk weightings of relevant assets, it is set to steer an  increasing proportion of bank and insurance funds into renewables, which, given they are uneconomic, will require further base monetary expansion or increasingly negative rates and government control to underwrite. 

Whilst real yields are not yet at the level of the major clearing events of the past, and I  wouldn’t expect them to get there for another 10 years, the risks are clearly increasing, and for the purposes of this note, it is the path to that point that we need to worry about. If real yields follow their trend declines to around -5% over the next 10 years, which I would suggest is justifiable by government policy, the literal interpretation would be a 25% fall in  real GDP, similar to the Great Depression, highlighting the scale of the problems we potentially face. 

This doesn’t just mean economic decline, but also changes in relationships  between, amongst others, the government and the governed, which can be seen in many areas already. By increasing control and adding to the imbalances, governments are buying  individual public support, but in doing so, socialising costs, and thereby de-skilling  individuals and devaluing its people and society; the government is getting bigger, but  devaluing its own currency. 

By determining how capital is allocated, the government is not only defining the absolute and relative value of output but is also determining the value of each of us and how we relate to each other. This is at an industry and skill level, at an economic level, at a social level, at a demographic level; it is at all levels. The cost of controlling those internal relationships is loss of capital at an overall level, and therefore slower GDP growth  and eventual decline. 

Through the global imbalances, the government is implementing similar controls at an international level, for example determining what American and Chinese people produce and consume, but at a cost of overall loss of capital. For individual countries to  protect themselves from these international imbalances, such as from competition from a  state subsidised company, or one that has benefited from China’s one child policy reducing  the cost of labour and investment, it would have to use capital controls to ring fence itself  from the rest of the world, making it too expensive. 

Instead, the imbalances have become global, which means any clearing of them, must also be global, either in terms of all countries  reforming or the relationship between different countries changing, like after WWII. 

Government control can be direct, but also indirect with new policies, like stones in a pond,  sending ripples out that have impacts that could not be foreseen. The policies that resulted  in asset price inflation, for example, have had many knock-on effects, but what original  policies were they? I would attribute the asset price inflation to Reagan’s changing of the  entire body of anti-monopoly law to protect the “rights of consumers” rather than of citizens, which was taken a step further by Clinton who also applied the same logic to foreign state monopolies. 

This unproductive allocation of capital was then financed by Greenspan and his  successors lowering interest rates, bridging the gap between the revenues paid to the  monopolies and the productivity they generate, or between asset prices and the GDP supporting them with the consumption of capital and less competition, resulting in the  monopolies and increased concentration of wealth. Some of the ripple effects – (the capital  that has been consumed) - are that by raising asset prices relative to GDP, the youth have  had to push back investment in housing, marriage, and children, reducing fertility rates and  altering the demographic. 

Unable to afford to invest in a family, the young have instead spent  their money on entertainment, creating new markets and industries, such as in social media and gaming, which has become a channel through which much of the capital is being  consumed in unproductive activities. By creating the initial imbalance, funding the sale and  purchase of goods at a lower price than the cost of production, the government has not only  created the overall imbalance, but changed relative prices and relationships throughout the  economy, all of which would necessarily change if the system were allowed to clear. This  could mean more or less of a product or changing how it is produced and what it is used for,  but without clearing the system of government, we cannot know what the true value of  something is because it is only by optimising the economy and society as a whole that we can  optimise each relationship and thereby find out the real value of products, rather than the  government dictated values. 

Unfortunately, this means that many so-called experts, which  are rolled out on news programmes and in the media to give opinions, and the bodies they  represent, are just expensive echo chambers for the unproductive government philosophy,  and therefore imbalances in one form or another. Given the feedback loop between the  government and these experts, you can see why the imbalances keep compounding and why  neither they nor the government can understand that they are the problem. Instead of  recognising the problem, we should expect more of these bodies to be created, supporting  bigger government. 

By shifting things away from the productively optimal level,  the government has been moving industry, economics, society, and politics away from science and hard reality to philosophy, replacing real capital and real wealth and wages that the  science represents with soft ideas that do not pay for themselves. It is reversing the Renaissance and Age of Enlightenment to a form of political religion where “science” is  increasingly used to reinforce the government’s explanation of the world. Without these distortions, government control beyond codifying and enforcing the natural law would necessarily decline, as it would be cleared as an unproductive cost that the economy could not afford. 

To prevent the system clearing, the government must add to the imbalances, moving prices  increasingly further from their productively optimal level, adding to risks. This doesn’t mean purposefully going and finding something that won’t work, but rather extracting capital from  another part of the economy to sustain the existing imbalances, thereby further misallocating  capital and adding to risk. To sustain the European Union’s goals on renewable energy, for  example, the European Commission has stated that, as the scale of investment required is  well beyond the capacity of the public sector, its main objective will be to channel private  financial flows into relevant activities. 

It will propose changes to bank rules so that environmental, social and governance (ESG) factors are core to managing risks on their books. Insurance capital rules will also be similarly amended. On the other hand, referencing  audited accounts on the capital and operating costs of 350 of the larger onshore and offshore  wind farms in the UK commissioned between 2002 and 2019, the report The Costs of Offshore Wind Power: Blindness and Insight, concluded that the costs of building and operating  offshore wind energy per MW of capacity is rising to such an extent that the current set of  offshore projects being constructed and planned in North Western Europe are closely akin  to speculative property development. 

They are high risk projects that will only be able to  repay lenders and offer a return to equity investors if the average wholesale power market  prices rise to at least three to four times their current level throughout Northwest Europe. Not only will government mandate private and public sector money into these unviable  projects, but it will also then have to further socialise that risk to avoid the system clearing  by taking rates increasingly negative or expanding base money to make good in nominal  terms the pension funds and banks it has directed into these unproductive assets. Whilst I  have used a renewable energy example, the government must underwrite all imbalances  with increased control, whether that is through monetary, fiscal, or regulatory policy, all of  which will become much more extreme.  

For the financial markets, assuming governments keep the inflation in asset prices, this will  mean going further along the risk curve, taking valuations to more extremes. Assuming  lower interest rates are used to carry more debt relative to GDP, as it would increase the  present value of future earnings, it would direct money into longer duration assets,  flattening curves and reducing term premiums. This already involves pension funds going  further along the curve and shifting from the traditional 60%/40% equity bond portfolios to higher equity and other higher risk asset weightings as the interest income from the  bonds’ declines. Within equities, growth stocks should continue to increase relative to  value as growth itself becomes increasingly rare, and as the reduced term premium  increases its net present value. As already discussed, it should mean fewer companies, both  at the domestic level but also international level. It would also mean junk spreads  tightening further against investment grade, and emerging market spreads to developed  markets also tightening as the Fed is forced to pump more dollars into the global system  to float all ships to prevent the system clearing. Overall, it means a continuation of the  trends we have seen over recent years.  

To move assets away from their productively optimum value – (it is not “fair” value as that  will move with base rates which are being dictated by central bank policy) – increased control  is necessary, concentrating wealth and power and socialising the costs. Whilst the need for a market to create the revenue stream to service the assets means that the rest of society  collectively has as much power as the wealthy – (the liability side of the wealthy’s assets) - as it would be divided over millions of people, their ability to act as one to use that power  will be very limited, as elections highlight, which is why government is able to take ever more  control without being challenged. This identity also highlights the stupidity of the present  system, that whilst the public collectively has as much power as the elite, they have allowed such an imbalance in wealth to form. Nevertheless, as Catastrophe Theory suggests, at some stage, when the imbalances and risks reach a certain level, forces that previously opposed  each other are likely to come together and act as one, taking power back from the  government. 

This could be organised through groups forming and acting together or random  independent actions and events combining in such a way to clear the system. Until that point, the imbalances will grow and the power concentrate in fewer hands, leaving fewer people able to afford their own house, to have children, or retire, or even vote for change as they  will be increasingly dependent on government handouts or lower interest rates affording  the increased debt and assets more generally relative to GDP. 

This again highlights that the system will probably not clear other than if it falls of its own weight, when the imbalances are so large that enough of the public abandon the traditional parties in favour of leaders that offer an alternative view, or, if the clearing is imposed by another country, most likely rejecting an aggressor’s call on its capital to sustain its imbalances, like WWII. Part of the  clearing process must be for the public to realise that they are not being told the truth – (by  shifting values away from the productively optimal level, government is corrupting reality) - which is a necessary part of the imbalance of moving things away from the productively  optimal or true level, which is why control of the Internet and media is so vital to sustaining  power. 

With the government clearly not understanding the implications of its policies, mistakes can be made that could bring the house of cards down. There have been 3 major corrections in asset markets over the past 20 years alone, which required major policy stimulus or additional control to prevent turning into proper clearing events. 

The enormous demonstrations and empty cafes and restaurants in France at the moment suggest the  government may have miscalculated in its policies related to the virus, and similarly the complete polarisation of politics in the United States, and the growing global mistrust of China, but these are all likely just objections to specific policies or politicians or events rather than the overall trend of imbalances as no one is going to voluntarily crash the system. 

Europe’s renewable energy policies are raising prices and squeezing household budgets, leading to diversionary policies such as the carbon border tax to deflect some of the cost abroad, but like former President Trump’s tariffs on China to try and accommodate existing unproductive policies, they are just new imbalances, and are unlikely to result in the system  being pushed over the edge. 

The cost of the imbalances are just not high enough yet for the  public to reject the government or even roll back some of the unproductive policies, that would at least partially give the economy back its legs like Roosevelt did when he rolled  back some of the New Deal, enabling U.S. industry to compete profitably for government  contracts, which then helped clear the imbalances and restructure the global economy and society. 

The idea that Fed Governor Powell is going to tighten monetary policy to a level  sufficient to start clearing the system over the medium term, or not going to loosen policy to  prevent the system clearing, is laughable, which means the system can only clear by rejecting  the kind of big government and central bank we have today. That is not going to happen until  costs of the imbalances are high enough, which in my opinion is not until the true cost of the  renewable energy policies become obvious for all to see. 

This means we should expect more imbalances. By regulating that we consume certain  things, most obviously renewables, the government will price out other things. Whilst it intentionally wants to price out internal combustion (I.C.) engine cars, Stellantis has warned that it "could price (the) middle class off the roads". Electrification could make cars too expensive for the middle class, making driving the exclusive preserve of the rich. By raising  the cost of moving things around, including people, it will crush productivity and real wages,  turning the public against the government. Obviously, this applies at a far broader level; by  pricing out energy, government policies are pricing out GDP and imposing poverty on us all.  

CEO Carlos Tavares’ comment that "I can't imagine a democratic society where there is no freedom of mobility because it's only for wealthy people and all the others will use public  transport" should be taken literally, i.e. to have a democracy of any value, the system will  have to reject these policies.  

The counterparty risks are at every level. The identity between input and output or between  demand and supply means that the government’s power is both an asset but also a liability,  which means there is counterparty risk between the two. The government controls the  people but in return it must deliver what they require to keep that contract in place. At any stage the public can walk away. Whilst the government can use force or rather increased  control to maintain its power, which is what the imbalances are buying, at some stage they will have insufficient capital to avoid that default. 

Obviously, we are seeing policies becoming  more extreme, compounding the risks and the costs of containing those risks. As the real return on capital has gone negative, rather than borrowing growth from the future, the government is borrowing output from the future. In doing so, it is ensuring future output follows a declining path. If it borrows output from the future, supporting clearly unproductive spending as it has done over the past 18 months, the declining trend of GDP  will accelerate lower. 

Whilst U.S. GDP has rebounded heavily from its lows, with all output priced off 25 bpts base rates, which when adjusted for USD120bn a month of base monetary expansion is heavily negative, the rebound in output and jobs is at the expense of capital depletion and will therefore be given back just as the bond market’s negative real yields  indicate. 

Whilst bad enough for the United States, for the Eurozone, Britain, and Japan, which are still a long way short of their pre-crisis levels, it is extremely worrying. Whilst this is very different from the past when we were borrowing growth from the future, when the loss was just an opportunity cost, it still does not mean the public will force the system to clear.  

Unfortunately, the only point where government can no longer borrow output from the  future is when it has totally exhausted capital, at which stage we are all dead, however  history does show that a long time before then, when real yields fall to around -5%, it loses  sufficient political capital that the system does partially clear. We are still a long way from  that point. Instead we should focus on new imbalances and where that will take us, before the system eventually clears. As long as the system continues to add to imbalances, real  yields will fall, net investment rates decline, and capital stock and GDP fall at an accelerating pace. 

How negative will rates go, how much base money will be printed, and  what share of the broad money supply will the central banks’ control? How and where will  they direct that money? 

Will it go into specific targeted technologies and industries, like the Made in China 2025 plan, the European Sustainable Finance Framework, or the various U.S. stimulus plans, and how will that change how the public and countries relate to each  ther?  

Whilst most politicians act with the best of  intentions, by moving the allocation of capital away from how it is produced, the government  corrupts the system, creating the imbalances we have today, which we are all suffering the  consequences of. Although I would say most of our politicians these days are low quality, the  problem is not related to them specifically but rather to the system of unlimited government  generally, as it is tasked with making decisions on which it cannot possibly have all the  necessary information at any moment in time to make productively optimum decisions – (see  Keep Digging, Mr Keynes). It can bring the collective resources together to achieve a specific  result, such as to win a war, but it cannot ever allocate capital productively. 

Whilst the public will eventually recognise this reality, taking power away from the government for a short time to  allow at least a partial clearing of the system, we should not expect such a change in the short  to medium term as we are too far down the path to reverse course without a major disruptive event. Instead, we should expect the imbalances to continue to compound, with  governments moving the system further from economic and scientific truths until the costs  of the imbalances become unsustainable, at which stage no force will be able to prevent the  system clearing.  

Written by Andrew Lees

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The Macrostrategy Partnership, initially set up as AML Macro Limited, was founded in 2011 and  transformed into the MacroStrategy Partnership in 2012. We provide cutting-edge independent  research on global macro and markets, unconstrained by internal, external or political  considerations, assisting our clients to make investment decisions. 

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