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.