Recent events in markets have been a rough ride for most, with major indexes and individual stocks falling from 20% to as much as 60%, the market commentators and actors are not sure it’s over yet, and they never will be! Here one has to remember, when consensus is strong on one side, then the majority tends to be wrong.
So, is The Perfect Storm brewing or can we still hope for a nice landing? Which option are you willing to write?
The Magic Money Tree is being cut down as you read this. The last years of experiments with MMT will all end abruptly, IF QE ends up being withdrawn aggressively through QT and not just through expiry. Considering the recent impact of this we have seen in bond markets generally, and especially in periphery markets like Italy, monetary authorities will soon find themselves between a rock and a very hard place, or I should say, you and I, the hard-working investors, savers, namely the financiers of the irresponsible actions of governments.
Why is the Magic Money Tree being cut down?
The experiment with historically expansive monetary policy combined with historically expansive fiscal policies, spiced with the Magic Money Tree experiment, where central banks are monetizing (buying) the majority of the government bond issues back (= free money) looks to be ending badly, as common sense would suggest. In the theoretical world, where the central banks seem to live, one would have hoped that they had listened more closely to Dire Straits (what an appropriate name): “Money for nothin’ and your chicks for free. Now that ain’t workin’, that’s the way you do it. Lemme tell ya, them guys ain’t dumb”.
Do central banks believe investors are dumb? Or do we investors believe that every central bank out there with their +100 PhD’s each are dumb? I guess we will never agree here, but the lure of the Magic Money Tree was too big for everyone.
The current dire straits the world finds itself in, is being leavened with the US/Western-Russian proxy war in Ukraine and the fragile fiscal situation which is the product of the past 20 plus years. This all is creating a balancing act for central banks that has not gotten any easier, especially with our dysfunctional political actors globally.
Is there a way out of this mess?
None of us wants the Volker treatment, but none of us wants the economics to get into a growth state (recession) where yields again can come down, because both outcomes will be dire for investors, workers, and their families; so what are the solutions here?
To claim that yours truly has THE medicine for this fragile patient would be presumptuous, but we could have required exactly that from our central banks and fiscal operators. Isn´t that why we put them there? The best guidance I can give you is the lesson that I feel the last 10 years have taught, that over-meddling with the economy to smooth everything out just leaves an even larger bill to be paid down the road. Kicking the stone down the road (up the hill really) once again, will just make the future bill even bigger; remember, time costs money and the chicks ain´t for free.
No more financial engineering please
The plastering of the patient with new financial engineering needs to stop, since this is again just medication of symptoms; therefore, the one unpopular medicine economies have to take is saving through diligent spending (public and private), trying to catch up with the curve and balance the checks (debt and reality). This seems to be the way forward, maybe the only way forward! I know this is a boring idea, putting the party on hold. This solution is the one nobody seems to like, but up till now, the extra pill against the hangover, taking away the symptoms for a short while, has not solved the problem. And as we all know, it will not. History is a bitch, but she does provide for a lot of good suggestions, some we tend to forget. Most often the view “this time it is different” comes from the wrong optics or position (or interests), which is why I feel there is not that much new under the sun, gravity still holds us in place and the sun keeps us warm, warmer now actually.
While certain leaders and politicians, their support organisations, and the likes, seem to be caring just about the status quo (kicking the ball), to secure their own positions and wealth, the world faces much more dire problems through climate change. This problem, when compounded over time, will bring on changes of a whole different calibre, which central banks cannot repurchase, which we cannot control if things go wrong. This is a serious problem that no one really seem interested in doing anything serious about, and solutions seem still hindered by certain commercial interests.
So, how about if we started cutting military expenses by half? Re-allocating these bright minds and strong hands into something constructive and commercially viable? Such a move would fiscally contribute yearly a little less than $400bn for the US alone, and around $800bn globally (https://worldpopulationreview.com/country-rankings/military-spending-by-country). That would make serious contributions away from the destructive interruptions of people’s lives as well as a good fiscal saving, leaving hardworking men and women to provide for their families and country in piece.
Aside from the philosophical exploration above, the overriding theme and problem for financial markets is the levels of debt and the yields to be paid by our indebted world. Yields have gone up a lot, but real yields are still negative by historic margins.
Hard medicine, new medicine
Getting yields lower again requires new medicine through fiscal appropriateness, not financial engineering and hopefully not by leading us into recession. Procuring much higher yields would be crippling for all parties and lead to recession down the road, plus massive defaults, public and private. Transfer or elimination of liabilities through defaults, in one form or the other, seems to be the only certainty, no matter which path is travelled.
Defaults come in two forms, fast and slow. The fast default is the one that most people know of as default, where the debtor can or will not repay their debt. If markets implode, we will have banks, states, non-cash generative corporations and workers hitting the wall, badly. The slow form of default is the version where governments are slowly undermining your wealth through inflation, debt originators securing you lower purchasing power for your money the day your money is returned, if it is returned! The only hedge here is to participate alongside the governments through issuing your own debt. Just remember, unlike governments, you will face retributions and it might very well be too late now.
Consider this. Central banks’ financial securities portfolios which they have acquired through recent QE are in loss, IF they had to mark them to market. 10-year government bonds are down between 10 and 30% since year end 2021 (Germany down 19%). This situation is termed bankruptcy for you and me. This scary truth provides a bit of guidance to where and in whom one should place one’s trust and money.
Yours truly is a Danish citizen living in Switzerland, and the Swiss way of operating private and public fiscal discipline and debt has its shining moments, which become clearer and clearer the longer one resides in Switzerland in these times, even though the Swiss National Bank has its own balance sheet issues (though very different than the rest of the world’s). National central banks’ problems are one thing, think where this leaves the regular banking sector!
If there is one thing I have learned over time, and I started out in fixed income markets, it is to be very careful with making asymmetric investments, where you have the option between a little gain versus a large loss. For one, fixed income is not the same as a fixed outcome!
Travel safe out there and remember, logic and common sense are not always the travelled path of our agents, and it seems too much to ask for from these sponsored operators in offices. Have a safe summer and take care of each other.
