Out Of The Frying Pan, Into The Fire

By Michael Every of Rabobank

A Long-Expected Party Collapse

Expensive, epic flops are all around us.

The finale to the $1bn ‘The Rings of Power’ had Ga-Liz-riel making an epic screw up that reveals chaos and darkness. Its canon-shattering dross lacked the right script; costumes; lighting; cinematography; editing; direction; character development; logic, depth, and belief, without which it had no power to move us, and so managed the morphological feat of being both shallow and hollow. I have produced things more authentically Tolkien myself after eating brussels sprouts.

PM Liz Truss’s eight-minute, four-question press conference(!) after firing Chancellor Kwarteng — making him even shorter-lived than his predecessor Zahawi — was also canon-shattering dross lacking the right script; costumes; lighting; cinematography; editing; direction; character development; logic; and depth. However, the PM retained her belief: in Kwarteng, who is gone; in low taxes, which are gone; and in higher GDP growth, which is gone. Even pro-Truss journalists asked if she should be gone too, and many believe she soon will be given her government is powerless, shallow, and hollow too. Perhaps we get PM Wallace, Mordaunt, or Sunak and sensible policies: like paying people to eat in pubs, then closing them down because they caught Covid there. Until then, Chancellor Hunt will reverse floated corporate and income tax cuts to juice GDP growth, and cut, not raise spending.

Both ‘Tolkien’ Ga-Liz-riel and Tory Liz lazily copied-and-pasted things they believed were the keys to quick success:

“Let’s have Hobbits/top-income and corporate tax cuts though they shouldn’t exist in this timeline.”

“Let’s have Gandalf/Thatcher though he/she belongs in a different Age.”

Such is the crossover idiocy that we could soon see dramatized tax cuts for Númenor’s rich, who are already complaining about elves “stealing our jeerbs”, and Truss say the UK can heat itself with a Balrog. (After all, others’ energy policies are already as ‘magical’.)

The Shadow of the Past Policy Errors

Markets believe the BOE was right to force Truss to U-turn from the wrong kind of fiscal loosening for the supply side to letting growth slump while not dealing with the supply side fiscally, ensuring a lower GDP ceiling, and plummeting long-run socio-political and macro-stability.

Remainers believe rejoining the EU will solve all the UK’s problems, not just some, regardless of how the EU is doing on the supply-side and geopolitical front. (Or how the angry UK demographic who voted for Brexit would take a reversal: yes, let’s radicalise people even more, why not!) Clearly something needs to be done, and perhaps the EU or a ‘51st state’ future beckons.

Markets believe that having broken the Chancellor and PM, they can now break the BOE; then the ECB; then the Fed. From today, the BOE will have to prove it won’t step in to save markets: Gilt yields are going back up to test its belief in QT. So then we either end up with more instability, or more QE ‘as the key to quick success’,… and then different instability.

“Not all who wander are lost.” Some are lost without moving

Indeed, markets still retain a belief that inflation is transitory and a Fed pivot looms despite:

the low Mississippi river;
ocean carriers consolidating/scrapping vessels/blank sailing as freight rates fall;
the Ukraine grain deal maybe failing;
Russian metals to be banned by the G7;
Russian oil caps looming as OPEC+ production cuts do too;
the US SPR emptying;
diesel shortages;
Europe facing energy rationing and loss of industry;
US unions getting large pay deals or striking;
and on/reshoring trends.

Markets will keep looking powerless as inflation stays supply sticky despite demand destruction.

Central bank models failed to predict inflation, and none of their mean-reverting, GDP-by-demand, DSGE models have changed since: some ECB economists are now arguing rates can peak at just 2.25% when headline CPI is 10%, and the RBA believes similar nonsense. Such forecasts assume no nth-order effects, or supply side problems, and that things always mean revert. Or, for the RBA, that ‘housing is all’. The Fed is making some progress though: reportedly, it no longer believes in its own inflation models. It is showing its power to shock, as some now talk of rates higher than 5%, as the Fed thinks high CPI needs a demand-side, not supply-side response.

However, the Fed also thinks they can carry on with QT without blowing markets up. They will soon feel their powerlessness in the face of market wrath, or panic, if so.

Whichever past route to quick success you think you are copying-and-pasting, you are wrong if you are basing it on neoclassical economics. Indeed, other, totally-ignored schools of economic thought have different convictions and conclusions:

Austrians believe you can’t model an economy and that state intervention and low rates lead to malinvestment and/or inflation, which must be purged by letting the system crash: but this tends to crash social stability too. Austrians favour exogenous money (i.e., gold) to limit the power of the state: but that favours the strong over the weak, and those lucky enough to have gold and guns (personally and nationally) over those who have neither. Some like crypto, despite these having an infinite supply, because they aren’t state-backed – yet.
Marxists share ground with Austrians over “fictitious vs. productive capital” and the dangers of fiat, but believe capitalism will collapse due to how badly it treats workers. They have no idea what to do next, but follow-on Leninists believe you must accelerate that collapse, form a dictatorship, use the private sector to grow your capital stock provided the state kicks them out afterwards, and that war inevitably emerges from capitalism’s late crisis-prone stage.
Post-Keynesians believe 2008-style crashes are key threats, like Austrians: Minsky’s PhD advisor was Schumpeter. However, they believe tight regulation of banks stops malinvestment, not gold, and the central bank and government must support the economy via endogenous money/MMT – which creates its own malinvestment and inflation. They don’t have answers for supply-side issues that stop MMT from working, i.e., the US aside, you need a trade surplus.
Fascists believe in a zero-sum world and imposing unity domestically. This can also be watered down to corporatism or ‘state capitalism’, which many economies use or have used, or to ‘industrial policy’, which is back in vogue in the US.

What do you believe? That markets revert to equilibrium or collapse: and why? That you can lower rates, borrow, and live on malinvestment forever? That private debt matters, or public debt? That salaries can be trimmed: or revolution results? That you can print money and not collapse? That we can all run a trade surplus? That it’s a dog-eat-dog world?

Or are you lost without wandering (or wondering), and just repeating that “Tighten fiscal policy into a deep, geopolitical recession, and CPI will go down to 2% again because Balrogs”?

That seems to be where many sit, including the IM, who just told us to “buckle up and keep going,” rather than doing any new/old deep thinking.

Out of the Frying Pan, into the Fire

Meanwhile, in the background to these profound (political-) economic thoughts:

How many models of the Chinese economy match what The Economist just implied using satellite images taken at night – that it, and others, are much smaller than purported to be?
The 20th CCP congress cementing Xi’s third term began with him stating we are a “critical time” in history, and to be “prepared for the great tests of not only high winds and rapid waves, but also stormy waves and hazardous seas.”
He showed no backing away from Covid Zero. Or from Marxism, which is: “the fundamental guiding ideology upon which our party and country are founded and thrive. Our experience has taught us that at the fundamental level we owe our success… to the fact that Marxism works.” Don’t tell neoclassical economists and models backing capital flows into China.
He also underlined China must be prepared to “struggle” – meaning more in the Chinese context, while pledging, “We will improve the system of income distribution,” and “we want to regulate the mechanism of wealth accumulation.” As Wall Street banks in China go all in on wealth management as their strategy.
There was a call to promote the “spirit of frugality across the entire society,” which doesn’t sound like what the lines I still see are predicting about Chinese demand growth.
Externally, he added: “The wheels of history are rolling on towards reunification and the rejuvenation of the great Chinese nation. Complete reunification must be realised and it can without a doubt be achieved. We will continue to strive for peaceful reunification with the greatest sincerity and utmost effort, but we will never promise to renounce the use of force and reserve the option of taking all measures necessary.”
Elsewhere, Liu Mingfu, a hawkish retired professor at the PLA’s National Defence University, speaking in a personal capacity, proposed “socialism with Hong Kong characteristics“, as the autonomous region can only practice the “unscientific creed” of capitalism – which “will not remain unchanged in the long run.” (Again, sorry DSGE models.) This isn’t the first time this has been floated in public, but comes days after the HK authorities spoke of new visa and tax incentives to try to stop an ongoing brain drain.
Even the Wall Street Journal, which cheer-led US investment into China, now warns: ‘Xi Jinping’s Endgame: A China Prepared for Conflict With the US’.
Conversely, the new US National Security Strategy focuses on Russia and China from a whole-of-government perspective, including trade, industrial policy, regulation, and markets; and NSA Sullivan says the post-Cold War era is over. Very much so, it seems, as new US restrictions on China’s access to tech are so draconian they are seen as an “industry-wide decapitation” that may even echo the 1941 US oil boycott vs. Japan in some observers’ eyes.
The US is also busy threatening to stop selling weapons to the Saudis in response to OPEC+ production cuts; coming out in support of Iranian anti-regime protestors; calling Pakistan “one of the most dangerous nations in the world” for having “nuclear weapons without any cohesion”; watching North Korean missile launches and threatened nuclear tests; and facing rising tensions with Turkey.

Again, what does your model say about all this? If the answer is “nothing”, then it lacks the right script, logic, and depth, and rests on copy-and-paste neoclassical beliefs. Until it does have an answer, it will remain trapped in a ring of powerlessness