"This Is A Global Metacrisis": Markets Risk Replaying 1987, 1994, 1997, 2000, 2008, The Arab Spring, 2012, 2015, And 2020 All At The Same Time

"This Is A Global Metacrisis": Markets Risk Replaying 1987, 1994, 1997, 2000, 2008, The Arab Spring, 2012, 2015, And 2020 All At The Same Time

By Michael Every of Rabobank

Even the neoliberals don't want neoliberalism

“Are you now, or have you ever been, a member of the Neoliberal Party?”

Markets were roiled Monday, with another epic surge in bond yields. “Stocks and bonds have worst half in history” was the Bloomberg headline; as our own Christian Lawrence points out, it was the worst 60/40 portfolio return in 90 years, and the second worst in 122 years. Ouch! Then we saw a massive bear steepening of the US curve on the day, with 2-year yields +14bp to 4.34% and 10-year yields +24bp to 3.92%, the highest since 2010. Ouch again!

The neoliberal view since August had been that after reaching 3.50% the next destination for 10s was 3%, then 2.5%, then something far lower. To be fair, that’s how neoliberalism has worked since Volcker: lower yield highs, lower yield lows, cut rates, and let markets rip! Not anymore though, it seems. Some of that move was a likely selling of Treasuries to cover other liabilities as markets tumbled all over. Even so, the Fed’s Mester underlined yet again that US rates will stay higher for longer, and that ‘longer’ part of the message may be starting to sink in further down the curve – US 5-year yields were up 21bp for example, and the market is now pricing out any rate cuts for 2023, which was already our house view.

Bostic then added that the Fed hadn’t lost credibility with the public: the gentleman doth protest too much, as doth the markets.

This all ostensibly started with the UK and the flash crash in Gilts and the GBP, which Bloomberg was referring to as the Great British Peso yesterday. Poor King Charles: even before his face appears on UK banknotes, they have become less valuable. However, the fact that the crisis has spread shows the problems run far deeper than “Brexit”.

In particular, the radical tax-cutting UK budget from Friday and the weekend’s promise of more to come is a last roll of the dice for the Tory government; perhaps for ‘Global Britain’; and maybe for the neoliberal economic philosophy.

After all, the most diverse UK cabinet in history has produced what some call the most monomaniacally neoliberal budget in history (apart from vast energy subsidies that sit alongside the absence of any rationing); and it is publicly being called “The Economics of Narnia”, of “Lalaland”, “Kami-Kwasi”, and worse by non-neoliberals and by neoliberals.

Of course, those historical claims are wrong. Past neoliberal UK budgets allowed for the deliberate starvation of millions under the banner of free trade, as detailed here for those who think markets are untainted by the evident evils of too much state control: read it, even if just to argue back. Yet some voices whisper that the bait and switch is to slash taxes, then be forced to slash state spending to match. Wouldn’t that play well with voters right now?

Even the bankers richly rewarded in the UK Budget are betting against the policies in it. On the Great British Peso, my 2022 meme that “DM = EM”, was predicated on the view that an early rates pivot against a deliberately supply-constrained backdrop would see commodity prices surge, FX crumble, and yields surge. Clearly, massive unfunded tax cuts aimed at the wealthiest and asset markets produce the same outcome – who knew?! Equally, who knew Western governments would feel pressured into populist policies rather than saying “tough luck”?

As in an EM, now UK rates need to rise even higher than before: the market expectation is of a BOE rates peak of 5.75%, when many would not have bet on even 0.575% a year ago.

Yesterday, market whispers were of an emergency BOE inter-meeting hike. All we got was an anodyne statement from Governor Bailey basically saying, “The Bank is monitoring developments in financial markets very closely in light of the significant repricing of financial assets,” and that it would look at the issue at its scheduled meeting. Down went GBP again.

Markets will now test the BOE and the ‘Peso’ – and if they don’t hike, disaster. Worse, an emergency rate hike would put the BOE and the government at loggerheads – again a disaster. Logically, the BOE could ‘help’ by carrying out a rates pivot – and again it means disaster. Or the government could tighten fiscal policy against the current backdrop – disaster. Or it could loosen fiscal policy via more tax-cuts - we already see the market views this as a disaster. You can see why even neoliberals, and investors in UK assets, are back-tracking.

It’s not that neoliberalism didn’t have a good run. It won the Cold War via consumer and public borrowing the USSR could not match. It brought decades of global peace and prosperity (interspersed by US invasions, bombings, and drone strikes). It just also has a nasty tendency to collapse into the flames of war now and then, as in the 1910s, 20s and 1930s, and again today.

Let’s focus on the market scepticism of 1980’s neoliberalism for 2022 Britain:

  • Will the money the wealthy are to be given be channelled into supplies of energy and industry? Not the former, which fuels the latter, because the pay-off is uncertain. While we need fossil fuels now, we ostensibly won’t need them in 10 years or so. So, why invest tens of billions? Green energy also requires fossil fuel for its inputs, or new/rare minerals the UK does not produce. In both cases, the economy remains structurally hamstrung on the supply side.
  • Will the extra money the wealthy are to be given be channelled into a military response to Russia’s mobilisation, as PM Truss rightly argues, “Freedom must be better armed than tyranny”?  No. The latter is up to the government, which is increasing defence spending to 3% of GDP – without the taxes to fund it. And yet this is not the 1980s. The UK has large debts and little industry. The other side has low debts and huge industry, and key commodities. The West cannot ‘beat them without fighting’ with state spending as rates rise, or with consumer spending; and we *are* already literally ‘fighting them’ across different dimensions. (US rate hikes are doing a good job though.)
  • Will the new money be saved? Perhaps. But if so, will UK banks lend it to the above sectors only? No. They don’t do that kind of thing anymore. The money might flow back into Gilts given yields are soaring: but in that case the government is doing all the heavy lifting, while paying 5.75% interest on top for no reason.
  • Will the tax-cut money be spent? If so, welcome to higher inflation and rates! Or perhaps the wealthy will buy a new, larger house, and screw the energy bills. That’ll show the Russians!

As markets are showing, this is not a British, but a global problem. It is rooted in a neoliberal ‘lower for longer’, financialized economy facing up to much higher rates driven by a structural real economy supply-side shock. Indeed, markets risk replaying 1987, 1994, 1997, 2000, 2008, the Arab Spring, 2012, 2015, and 2020 all at the same time. As flagged in January, this is a global metacrisis.

Europe is grappling with an energy crisis the IOGP sees lasting for 3-5 years, as NordStream 1 gas supply goes down, perhaps under sabotage; a German recession; a Russian mobilization; the need to re-arm; and key German firms like VW and others saying they will stop local production if energy prices don’t decline. And it has a new Italian government to complicate EU decision-making. The new Italian PM is no neoliberal.

Italian 10-year yields were +14bp to 4.55% on Monday vs. 1.05% at the start of the year. The ECB talked vaguely about its toolkit to cap yields, but Lagarde also said would not fix “policy errors”: was she referring to Italy, her rate hikes, or decades of neoliberalism? She also decried EU governments for spending, making her rates task more difficult. Yet would it be better if energy prices soared, and inflation with it? Disaster or disaster – you choose.

In Australia, the RBA keeps promising to under-arm bowl its base rate not much higher than 2.50% and to soon move back to tiny 25bp hikes to save the housing market. It risks following in the UK’s policy wake with a lag. AUD is sagging, trading below 0.6450 this morning, and Aussie yields are being dragged towards their June peak (with 10s at 4.08% vs. a 4.20% 2022 high and 3s at a new 2022 high of 3.77%), and the RBA’s credibility is being dragged through the mud.

In the US, as the Fed hikes, the stock market and housing market crumble. Meanwhile, President Biden is telling US companies to cut pump prices of gasoline, when their margins are only 2c a litre on retail sales, and the Democrats are pitching that the government should buy and sell up to half of the Strategic Petroleum Reserve (the remaining half, presumably) to keep energy prices down. The Buy Low and Sell High Act would obligate purchases below $60 and sales above $90, as well as massively expand stockpiles of refined products across the country (at a time of no spare refinery capacity). None of this oil would be allowed to be exported to China, or nations under US sanctions. Whether it passes or not, this shows a further breakdown in neoliberal thought, and takes us back to deglobalised, price-constrained markets that were once normal for many commodities.  

Meanwhile, it’s not just the West seeing things crumble.

Iran faces country-wide street protests. It’s possible, if unlikely, the regime could fall. Certainly, the young generation seem as keen on Tehran’s leadership as young Britons are in the Tories.

There were also wild --wrong!-- rumors on China over the weekend, where CNY was officially fixed above 7 for the first time since 2020 yesterday, and fresh lows await. Everyone is grasping at air as to where this all stops: I used to say 7.75, where the HK$ used to sit, and 8.28, where CNY used to be pegged to the dollar, but that was just a directional anchor. Worse, pork prices are surging, apparently up 30% y-o-y last week, prompting more dips into the Strategic Pork Reserve.

As Russia’s Ukraine referendums/territorial grab comes to a close this evening, its matching mobilisation appears unpopular: martial law and closed borders ahead remains the rumour. Economists @mironov_fm and @itskhoki argue the maths says up to 1m men may be mobilised. While that seems a small number for Russia, because of the demographic hole of the 90s and early 2000s, there are now only 7.3m men aged 20-29, many of whom are about to be killed, injured, or flee abroad. Other reports make clear the weight of conscription will fall outside Moscow and St. Petersburg, where Russia’s extractive industries are found. The short-term economic impact could therefore be as catastrophic as the long-term demographic one. Some are even talking about the threat this could pose to the entire Russian state ahead.

While not underplaying what the Russians may ultimately prove capable of if they mobilise, the tale of an Estonian conscript’s week in 1984’s Soviet Army is still instructive. To avoid shooting-range duty, without bullets, he takes army vegetables to a school in exchange for used squat toilets; these are taken to an apartment construction site, and he is told where to find discarded timber, with which he builds a cabin for an officer. Then he installs bathtubs in the apartments, which allows the theft of a Finnish bathtub for an officer in exchange for stolen jet fuel; the Soviet bathtub swapped for it is to transport vegetable scraps from the army to a pig farm – but there are no longer any vegetables; so he steals potatoes from a collective farm using tools stolen from farmers and the fire brigade. Half go to fill the army’s ration stores; the rest are divided among officers, and sold privately as “dacha grown”, or swapped for sugar or Finnish chocolate.

In short, it’s not just neoliberalism that doesn’t work: Pepe Escobar, where art thou?

If there is anything that does work now, it is long cash and the US dollar. The neoliberal trade was to sell the DXY at 105, 110, but who knows where it now stops: 115? We were at 114.5 at one point yesterday! 120? Why not? But why stop there?

There is naturally market chatter about a new ‘Plaza Accord’, which is not at all neoliberal, but serves those who want to see markets stabilize quickly. However, this also displays little grasp of the US-Japan relationship in the 1980s vs. the US-entire world today. How would the dollar be forced down against all major FX when US rates are going up, inflation is high, and the US is proving itself to be the least dirty shirt in the dirty laundry basket?

At some point, this will become directly geopolitical, not markets driven. The Fed will throw out swap-lines to stabilise other markets. Yet this will NOT happen on “neoliberal” or global terms. Rather, the deal will be for US friends only, and as part of a realignment of supply chains that favours the US. It might even happen under the auspices of a digital dollar to reinforce the muscle of the Eurodollar system even further.

As an example of what this might entail, in order to get the nuclear subs underpinning the AUKUS pact as soon as possible, Australia is reportedly expected to pay to expand *US* ship-building capacity, the product of which will flow south, before it makes its own. Will the US also now get European heavy industry and high value-added auto manufacturing, alongside high-end semiconductors? And that alongside slices of off-shored Chinese production flowing to it and to Mexico? Tell me how the US doesn’t without using neoliberal terms like “because markets”.

Then tell me how this impacts assets without using neoliberal terms like “because markets”.

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