About the Author: Larry Hatheway is the co-founder of Jackson Hole Economics and the former Chief Economist of UBS.
The investment landscape seems quiet. Global stock markets are trading near all-time highs. Bond yields have stopped falling. The foreign exchange markets are calm. The market’s âfear signalâ, the implied volatility of equities, tends to fall, a sign that investors are not anticipating the cuts.
Yet the fault lines of markets usually extend for miles below the surface, out of sight. Occasional tremors remind us of their presence.
In the 1960s and 1970s, excessive government spending and lax monetary policies degenerated into high inflation. From the mid-1980s to 2008, unfettered borrowing and questionable financial practices precipitated the market crises of 1987, 1992, 1995, 2001 and âthe big oneâ of 2007-08. Last year, a pandemic highlighted the weaknesses of inadequate public health arrangements.
Small earthquakes often contain valuable information about what lies beneath. Some observers see the ground moving. But otherwise, the tremors are weak enough to be ignored, sometimes at great expense.
In 1967, Milton Friedman pointed out how flawed economic analysis and flawed public policies could lead to spike in inflation, which duly occurred over the next decade. In the 1990s, Alwyn Young noted that the âmiracleâ of Asian growth was built on excessive investment, a vulnerability exposed by the devaluation of the Thai baht of 1997 and the waves of emerging market crises that followed.
In relative obscurity, economist Hyman Minsky has spent a career building a thesis that stability leads to instability. His work has been ignored by overconfident lenders, homeowners and central bankers as the greatest âMinsky momentâ of our time approaches – the 2007-08 global financial crisis.
Today, beneath the calm surface of the global economy and markets, seemingly unrelated vibrations are forming: pandemic, unprecedented biodiversity loss and climate change, populism, anti-globalization and rising authoritarianism. Or perhaps, as historian Niall Ferguson recently pointed out, they manifest a common fault line that calls into question the viability of the company, its norms and rules.
All markets are rooted in trust, backed by the rule of law. However, the law is born of the government. In a democracy, the law reflects the consent of the governed; in autocracy, the will of the powerful. Since the 18th century, democracies and even many autocracies have found it helpful to support markets by establishing standards, rules of conduct, and laws that protect property rights and support the freedom to trade.
Democracy is uncomfortable alongside capitalism, where the power to “vote” is proportional to income or wealth. Autocrats may feel, or even fear, the power of accumulated capital. Capitalism creates the prosperity to which liberalism aspires, as well as the economic power which strengthens the hand of the autocrat. But capitalism also competes with the authority of those who govern it.
History suggests that governance is more fragile than it appears. The First World War shattered illusions of balance of power, globalization, colonialism and empire. In the 1920s and 1930s, communism and fascism decimated the ideals of Wilsonian democracy. None of these cataclysmic results were predicted by the markets, although some contemporaries, especially John Maynard Keynes in The economic consequences of peace– felt the tremors.
Brexit, Trumpism, authoritarian China, vaccine skepticism and climate change denial are the contemporary upheavals of a world that has lost faith in the moorings of the Enlightenment: democracy, freedom, scientific method, empiricism and economic liberalism.
Globalization, the most successful anti-poverty “program” in history, is now on the pillory. President Biden is eager to undo many of Donald Trump’s policies, with the notable exception of restoring the United States as the hegemonic leader of free trade. Xi Jinping’s China has gone beyond suppressing political dissent: it can no longer tolerate economic or financial rivalry with its supreme power. Britain sees itself once again outside of Europe, despite its immense historical, cultural, economic and financial ties with the continent. Europe is in the throes of its own political change, seemingly oblivious to the risks posed by autocracy and demagoguery.
Yet asset prices are appreciating, supported by strong corporate earnings and monetary policy, resulting in low borrowing costs. Equities have the privilege of being the only asset offering positive returns net of inflation. Stability, as Minsky might have said, provides the assurance of stability. Quakes are simply opportunities to buy more stocks at lower prices.
It may be justified. Maybe rationality will prevail. Data and logic can win over vaccine skeptics. Democracies and autocracies can gently curb the excesses of capitalism, without doing too much harm. The commons can become our focal point just in time to limit near-existential threats from biodiversity loss or climate change.
Or maybe not.
The past renders few verdicts on the future. Change is sometimes evolutionary, sometimes revolutionary. Continuity is not a given.
The ideas of Keynes, Friedman, Minsky, Young and Ferguson have little in common. They did not tread the same political, economic or ideological terrain. But they shared something more important without doubt. They knew when to listen, when to look. They knew not to ignore what they heard and saw.
Markets today behave as if normalcy persists. We hope they are right. But hope is not a strategy. Caution requires that we observe, listen, and maintain a healthy respect for what could go wrong.
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