In this issue of Capital & Conflict… the irony of sovereignty… asking the European Court for permission to leave… inflation returns… how to admit you’re wrong like a central banker… and why gold is suddenly back in fashion.
Well you have to enjoy the irony. Anyone who voted to leave the EU in order to reassert the sovereignty of Parliament over Brussels got a surprise yesterday. The Lord Chief Justice ruled that for the government to trigger Article 50 without the consent of Parliament is “contrary to the fundamental constitutional principles of the sovereignty of Parliament”.
How’d we end up in this mess then eh? The referendum – the will of the people – isn’t enough to assert the sovereignty of Parliament over Brussels. Parliament itself must do so. But will it?!
That’s the question now. So what do we know?
We know the government won’t accept this decision. It’ll appeal to the Supreme Court. The date for that appeal will likely be between 5 and 8 December. Which means we have at least a month of political wrangling. How fun.
We also know that the markets took the decision as a signal that for a “soft” Brexit, or perhaps even no Brexit at all. The pound rallied 1% against the dollar on the news. That used to be a big move. Now it seems like par for the course. Among all the uncertainty the only certainty is volatility. Get used to it. Understand it. Trade it! More on that another day.
Why would the currency markets respond positively to Brexit?
I see two reasons:
- Because the involvement of Parliament will force the government to bring its negotiating strategy to the debating table and likely introduce conditions before Article 50 is invoked (for instance, that Britain keeps access to the single market).
- Because Parliament will refuse to grant the government permission to invoke Article 50 and Brexit will be history.
You might think one of those options is more likely than the other. But if you had an interest in politics and were feeling particularly Machiavellian you might consider it.
Put yourself in the shoes of an MP with a comfortable majority. You supported Remain. Your constituency didn’t. Let’s say 70% of it voted to Leave. Given the chance to vote in Parliament, what do you do? Stick to your principles and vote with your own conscience? Or do you vote for the wishes of the people who sent you to Parliament to represent them?
Ready for another dose of sweet, sweet irony? What if, in appealing to the Supreme Court, this opens another can of worms? For instance, the Supreme Court may ask itself the question of whether Article 50 can be “un-triggered”. If Parliament votes to trigger it and then Teresa May calls an election, in which a new Parliament is elected, can that Parliament undo the decision of the first?
Let’s say the Supreme Court asks itself that. It’s hard to answer. No one really knows. The only recourse the Supreme Court would have is… you guessed it, the European Court! The highest court in the land on matters of the EU.
That would lead to the rather strange case of the European Court granting the Supreme Court permission to uphold the sovereignty of its own Parliament. Pick the bones out of that one.
As I said what’s clear from all this is we’re in for a more uncertain period than perhaps we thought. Markets don’t like uncertainty. So expect even more volatility. Next week we’ll look at what you need to do with your money on that front.
I have good news on that front if you’re looking for a simple and easy way of investing your money that could help see you through. It doesn’t involve taking huge risks or investing in the biggest trends, but if you’re at a loss as to where to put your money in the midst of all this: check back in next week.
How to admit you’re wrong like a central banker
The financial and monetary ramifications of Brexit continue to unfold. Yesterday the Bank of England made several adjustments to its forecasts for inflation and growth over the next few years.
“Adjustments” is a euphemism in this case. What the bank actually did was admit it was wrong in its forecasts and in its stimulus policy. It just didn’t announce it quite so boldly.
The headlines are these: short-term growth is predicted to be much higher than the bank had forecast, and so is inflation.
The shift of growth expectations from 0.8% to 1.4% is the biggest “upgrade” the bank has ever made to its forecasts. Inflation will pick up to 2.7% in 2017 and 2018, before dipping back to 2.5% in 2019.
I guess we can all go home then. The bank has got everything figured out.
Or has it?
It’s already performing a sharp about turn on its planned interest rate cut and stimulus programme. The interest rate cut likely won’t happen and quantitative easing (QE) won’t be extended. The economy doesn’t require it any more.
You could view this one of two ways. Either the bank really was a part of “Project Fear” – an attempt to scare people into voting Remain by making dire predictions about the economy in the aftermath of a vote to Leave – and its actions are now an admission it got things wrong.
Or you could take it as an example of how difficult it is for anyone to forecast the performance of the economy during a complex time with any real accuracy. It’s probably impossible. If you don’t understand it and can’t forecast it, you shouldn’t try to “fix” it.
To me, admitting the limitations of your knowledge would actually be the intelligent thing to do. Be smart enough to know what you don’t or can’t know.
But in the case of the bank, admitting to a knowledge deficit would erode its authority and ability to interfere in the economy. So don’t expect that any time soon.
Gold suddenly fashionable again
On the subject of central banks admitting to their mistakes, one of our experts, Eoin Treacy just sent me a note on the recent actions of certain central banks and the performance of gold.
As he puts it:
Do central bankers ever admit they are wrong?
Not in my experience. A recent interview with Sweden’s Riksbank governor Stefan Ingves is a great example.
When asked a question about the ramifications of his extraordinary monetary policy, he quite clearly admits that a bubble is expanding in the Swedish property market and in the same breath says it is not within the remit of the central bank to do anything about it. In fact, like other central banks, asset price inflation is viewed as a positive despite the fact household debt is at a record and the bubble is still inflating.
The whole interview is quite illustrative of the complacency of central banks when married to a narrowly defined measure of inflation.
The dollar broke out against the krona last week and extended the move this week. No one at the Riksbank will be mourning the currency’s weakness since this is exactly what Thursday’s statement was designed to achieve. A clear downward dynamic would be required to check momentum beyond a brief pause.
It’s the same story we’re seeing the world over. In fact, we’re seeing it here. Central banks want to see inflation. It’s their way of helping indebted governments inflate their debts away and transfer wealth from savers to borrowers. It’s wealth repression, pure and simple.
But they can’t admit this openly. And neither can they stop their actions having unintended consequences in the system… some of which can be profitable if you understand. Back to Eoin:
Broadly speaking, the actions taken by the Riksbank are symptomatic of the conundrum facing other central banks. Having fully endorsed the view that inflation is always and everywhere a monetary phenomenon, they have failed to understand that they continue to deal with the after effects of a credit crisis and much of the new money created has gone to servicing debts, rebuilding balance sheets and rich profits for asset holders.
There are really only two ways to foster inflation.
Write off the debts, then stimulate to raise asset prices which would make the holders of depreciated assets whole.
Alternatively, depreciate the currency to unimaginably weak levels which erodes the debt by allowing liabilities to be met in nominal currency at a fraction of the original value.
Neither of those things has happened. Yet. So far we’ve gone down a third route: little debt has been written off and the state has absorbed almost all liabilities. Central bank balance sheets exploded and asset prices have accelerated. In the most desirable areas, property prices have exceeded their previous peaks.
The question is, what do they do with all the debt on central bank balance sheets?
Actually, the real question isn’t what do they do with it. It’s what do you do with your money to protect yourself from whatever crazy scheme the authorities come up with. On that front, Eoin looks to gold:
I often think that the role of gold as a hedge is misunderstood. It did well in the 1970s because investors were worried about inflation and outperformed from the early 2000s because people were worried about deflation.
Therefore, it is probably best to think about gold as a hedge against the best efforts of the monetary authorities to debase the currency; regardless of what that currency might be.
Very simply, we don’t know how the massive piles of debt accrued by central banks are going to be managed. We don’t know how the additional debt taken on to fund deficit spending (fiscal stimulus) is going to be paid for. If history is any guide, a good portion of that debt is going to be paid back in currency that has been debased in one way or another. These are very big questions and gold is one of the better insurance policies against an unruly outcome.
The US Dollar Index is comprised of euros (57.6%), yen (13.6%), pounds (11.9%), Canadian dollars (9.1%), Swedish krona (4.2%) and Swiss francs (3.6%). Considering these represent the countries with either the greatest threats from deflation and/or developing housing bubbles, we can reasonably ask whether the index is a good measure of currency strength. In fact, with increasing uncertainty about the outcome of the presidential election on 8 November the index could retrace some of the advance it has posted over the last few weeks.
Gold prices have been off the radar for many investors for the last six months, but in an environment where central banks are actively targeting lower currencies the allure of an asset than cannot simply be lent into existence is likely to increase. Gold and most of the other precious metals are now trading in the region of their respective trend means, so if demand dominance is going to be reasserted this is the area where we might expect it to occur.
The US dollar gold price showed the first signs of demand returning to dominance in the region of the trend mean this week. Upside follow through next week would go a long way to confirm, more than short-term demand dominance. Finding support above $1,250 on the first significant pullback would help to signal a low of medium-term significance.
Importantly, platinum, which led on the downside, also posted an upward dynamic this week, while silver broke out of its short-term range.
The gold mining sector has now also unwound a wide overextension relative to the moving average (MA) and can be expected to continue to firm if precious metal prices manage to resume their medium-term uptrends.
Next week is going to be big for the whole financial system. We can’t ignore the election on Tuesday. But I’ll get Eoin to track the situation in the gold market and share his analysis with you as the week goes on.
Until next time,
Nick O’Connor
Associate Publisher, Capital & Conflict
PS In other Brexit news, the entire country seems to have picked up an annoying verbal tick. I’m going to call it the “A means A” virus.
Brexit means Brexit. Leave means Leave. Sovereignty means Sovereignty. It’s strange.
When you’re in the pub tonight and you ask for a pint, be sure to tell the barman: “A pint means a pint!” – just in case it isn’t clear.
Category: Brexit