If you’re utterly mystified by the last few years of economic and political events, we’ve devised a narrative for you.
Central banks have crushed volatility. Financial markets are now stable.
The problem is, financial markets are just a reflection of the health of the economy. Central bankers have treated the symptom, not the cause.
And we rely on signals from financial markets to know when something is wrong. Was Brexit a mistake? Can the Greek government repay its debt? Is General Electric being dreadfully mismanaged? We no longer know.
Worse still, central bankers can’t distinguish between a correction and a crash. They don’t know the difference between a boom and a bubble.
Without the healthy gyrations, signalling, and accountability of the markets, instability has popped up elsewhere instead. Entirely new pressure valves are whistling. And just like the old financial market pressure valves, the tune they’re whistling isn’t pleasant.
But first, what do I mean by crushing volatility? What exactly have central bankers done?
They’ve tried to achieve their inflation targets, without paying attention to how much newly created money that required.
They’ve rescued banking systems, without regard for what’s actually in those banking systems.
They’ve lowered interest rates to reignite borrowing, without a thought for what this would do to savers, pensions and the returns on bonds.
They’ve manipulated currencies in currency wars, without considering the effect on other nations.
They’ve propped up stockmarkets, without a thought of where that leaves them when the stimulus stops.
They’ve rescued governments, without realising this only encouraged more spending.
They’ve facilitated backdoor bailouts through Target2, without noticing this also facilitates capital flight in the eurozone.
They’ve beaten back the business cycle, without caring about the build-up of investment mistakes and overspending.
In short, they’ve suppressed crises, swept imbalances under the rug and even financed the economic mistakes companies, governments and individuals have made. All for the sake of keeping markets stable.
It’s a gigantic effort to keep up appearances.
But the volatility we’ve been missing acted as a sort of pressure valve. It provided a mechanism for corrections. Where are we without it?
A world without economic pain
Back when Italy wasn’t in the euro, its current fiscal crisis would’ve just sent the lira tumbling. Instead, you’ve got a nation in a depression, and an entire continent in dire straits as a result of a debt bloom out of control.
The euro doesn’t know whether to go up for Germany or down for Italy. The European Central Bank (ECB) is stuck between a rock and a hard place on monetary policy. The Italian bond market reflects ECB policy, not Italy’s fiscal position.
What you have now is a world where financial markets don’t deliver consequences. Given politicians and their support bases are running countries, this is like having a toddler who can’t feel pain. Good luck learning not to touch the stove.
Of course, every now and then, we get short sharp doses of feedback in financial markets. Yesterday’s currency instability is one example. The euro, dollar and pound all lurched about. The Italian sovereign debt crash of May is another example.
But notice how each of these was born in the political arena. Trade wars, elections and Brexit are all that’s left to drive our markets.
The same goes for the US’ trade deficit, Greece’s debt, the developed world’s pension systems and our overleveraged consumers and companies. They’ve all been spared financial accountability. But politics is catching up with them.
Politics has become the pressure valve that markets used to be. In a world of artificial financial stability, how do countries become competitive, houses affordable, pensions funded and trade flows balanced? Politics.
The problem with this is that markets are very dangerous under political and central bank control. Because both are transient. Reality will eventually emerge. The damage of touching the stove is real, even if you can’t feel it in the FTSE.
The reckoning could be approaching as more and more central banks aim to end quantitative easing (QE). Without their support, what would markets look like?
If you agree with this narrative, the question becomes which political artifice comes crashing down first. Is it the ability of central banks to maintain control as they tighten monetary policy in coming years?
Is it the 2019 EU elections, when all that populism and euroscepticism sabotages the EU’s power structure and thin veneer of legitimacy from the inside?
Maybe. But I think it’ll come crashing down in Italy first.
The Italian crisis is back
In a coming update for Zero Hour Alert subscribers, I delve into the key days that we need to watch for in Italy’s coming sovereign debt crisis. I can’t give them away here – subscribers eyes only.
But one of the identified points played out yesterday. Three of the new coalition government’s most ardent and renowned eurosceptics were appointed to chair budget committees. It seems their parties have outmanoeuvred the president’s earlier rejection of their economics minister.
Italian yields spiked. The Italian stockmarket fell 2%, led by banks.
Is this a return to the crisis of May? Is it more manipulation from the EU and ECB to remind Italy it is accountable to markets if it wants to finance a budget?
And the big question remains: Will Italy default, leave the euro and trigger the biggest financial crisis ever?
Although the new chair of the Italian Budget Committee laid it out for you too.
“Europe has brought us a depression worse than 1929. It has led to entire peoples being broken and humiliated, like the Greeks, all for the sake of preserving the infernal instrument of the euro. This whole disaster has been adorned by a chain of lies, shouted ever louder because they are afraid that the colossal damage they have done will be discovered.”
If Italy were to leave the euro, “The losses would shift to the national central banks through the Target2 system.” It’d be the ECB’s problem, not Italy’s.
Find out what this means for you, and how to protect yourself here.
Until next time,
Nick Hubble
Capital & Conflict
Category: Market updates