The three things investors should know this week
Despite an ostensible return to centrism in France and the UK, voters remain resentful.
Delivering on growth, with little to no fiscal space and promises of low taxes for the lower and mid incomes is a very difficult proposition.
Debt will remain the weapon of choice, but its current levels and inflation make its use also difficult.
Summary
The political landscape ostensibly looks like something out of Jackson Pollock's paintings: impossible to understand at first glance, and allowing each viewer to draw their own individual conclusions. Yet a closer look at the numbers, suggests a string of themes that are all-too-familiar, and relate directly to the economy.
One: voters remain resentful: On many occasions, voters turned up their resentment, and it is only political systems that favour bigger parties, that have thwarted a rise of the extremes.
Two: delivering on promises is very difficult, as there’s no fiscal space, demographics remain challenging and productivity is low. Taxes might have to go up on certain occasions. Yet, the re-distribution of wealth does not have the same effect on growth as the creation of fresh money through debt.
Three: Thus higher debts seem to be the only answer going forward. Only with the current outstanding amount of debt and higher yields, as well as inflation, that proposition is now also difficult.
And the trend is likely to continue. Governments will continue to be faced with increasingly harder choices, and voters will become angrier as promises won’t be delivered, at least not without division along the lines of income, and sacrifice.
For investors, this also answers another existential question: is 4.5% yield for the world’s risk-free “an opportunity” or “appropriate”? Given the global debt profile and the promises that now need to be kept, we should lean towards the latter.
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An exhausting two political weeks came to an end. The result was the return of Labour to Number 10 after fourteen years, an uncertain and shaky coalition in the French National Assembly, and an even shakier candidacy by President Joe Biden.
Last week, UK politics returned to a (much welcomed) predictability, whereas French politics entered unknown waters and US politics thrown into turbulence, with Joe Biden becoming the first incumbent pressured to quit ahead of the election since Lyndon B. Johnson. **
The political landscape ostensibly looks like something out of Jackson Pollock's paintings: impossible to understand at first glance, and allowing each viewer to draw their own individual conclusions.
Yet a closer look at the numbers, suggests a string of themes that are all-too-familiar, and relate directly to the economy.
One: voters remain resentful
In the UK, the only two parties that gained a significant number of votes (a combined gain of nearly 5 million, for 21% of the total vote), compared to 2019 were Reform and Green. This means that five million voters directly challenged the narrative behind the return of “boring” to government.
In France, things are clearer. Mr Macron’s technocratic centre was haemorrhaging voters to his left and right, both of which are also significantly more militant, so he made a pact with the Left to thwart Ms LePen’s advance. He scored a pyrrhic victory, again thanks to the idiosyncrasies of the electoral system and disciplined behaviour by his and the NFP’s candidates before the second round, which essentially turned a proportional system into a run-off. Now the French President also has a tricky job at governing (lest he faces even angrier voters by the next presidential election) in coalition with the Nouveau Front Populaire. The latter is a coalition itself of La France Insoumise (Melenchon), the Communist Party, Ecologists, The Socialist Party, and other centre-left and left-wing parties united under a singular goal (stopping LePen) that has now been achieved.
Their common programme, assuming commonality is still there, includes undoing many of Mr Macron’s own reforms, like the 2023 French Pension reform, increasing public sector salaries and welfare benefits, raising the minimum wage by 14% and freezing prices at the supermarket, all of which should be paid by the same wealth tax Mr Macron lowered to foster the return of France’s wealthy after Mr Hollande’s presidency.
While Germany has not declared an election yet, the AFD and the CDU (which under Mr Mertz has taken a turn to the right compared to Mr Merkel), are significantly ahead in the polls.
As for the US? Resentfulness defines politics even more so than Europe. Four de-industrialised states, formerly known as the ‘Steel Belt’ but are now collectively called the ‘Rust Belt’, have become swing states and defined presidential elections in the past two decades. Pennsylvania, Ohio, Wisconsin and Michigan with a total of 51 electors out of 538 have been giving their vote to the highest bidder, compelling all candidates not only to try and deliver American re-industrialisation, but to demonstrate that they share the frustration of their constituents.
Two: delivering on promises is very difficult
In the UK, Labour has to deliver on growth, without significantly raising taxes (as promised), and against a backdrop of significantly reduced fiscal space and vigilant bond markets.
Mr Macron’s situation is similar to Mr Starmer’s. Raising tax receipts in a meaningful way is a difficult proposition, and fiscal space also remains tight, with France featuring a similar debt profile to the UK.
And if the two European leaders will find it hard to deliver, re-industrialising the American north, after years where globalisation moved blue-collar jobs to the east seems like a Herculean task.
In an economy that suffers from poor demographics (especially in Europe), where inflation remains sticky and where the fourth industrial revolution has yet to yield any tangible productivity gains (if anything, productivity is waning in the West), where, oh where, is the growth necessary to assuage voter frustration going to come from?
Either taxes or borrowing.
Three: Running on Debt
Avoiding a significant raise in taxes has been the cornerstone of the winner’s platforms across the board. Where the politics of anger have not yet prevailed, breaking that promise and taking even more money out of people’s pockets than inflation has, is a certain way for economies to reach a boiling point.
Certainly, some taxes can be levied on the ultra-high net worth, capital gains and possibly inheritance. But that won’t be enough to deliver growth back to the West, as income re-distribution can only go so far in improving efficiencies beyond a short-lived consumption boost.
In an era of stagnant demographics and lower productivity, the best way to increase marginal wealth is to create it through debt, and not only for the West. Since Covid-19, debt in the US has increased by 2.7% per annum, in the UK 3.2%, in Japan 3.3% per annum (one way to get the economy out of its own “Japanisation” has been even more debt), and in China a whopping 8.1%. This later number, even if it’s halved, will bring the world’s second-largest economy’s debt to GDP at 106% by 2028, almost where the US was in the turn of the decade.
Governments, long used to relying on central banks to create wealth enough to buy their own debt, are now facing an existential problem: inflation. Unlike the first rounds of QE, debt accumulation in the last few years has passed right through the economy, increasing the supply of money and creating inflation.
For investors, this also answers another existential question: is 4.5% yield for the world’s risk-free “an opportunity” or “appropriate”? Given the global debt profile and the promises that now need to be kept, we should lean towards the latter. In a world that could be more inflationary and a lot more debt-laden, it makes sense for investors to require higher returns for lending to governments and corporateions. If higher yields for longer are indeed the case, it makes refinancing government debt even more difficult, as it will significantly increase the profile on interest payments, leading to a vicious debt cycle, where debt is accumulated to pay more debt.
So governments not only need to consider the effects of extra debt but also the devastating effects of inflation, which renders the further creation of debt useless.
In other words, modern monetary theory (or the magic money tree as it often called) may not be able to produce much more growth going forward, any more than the re-distribution of taxes will.
Thus, the trend is likely to continue. Governments will continue to be faced with increasingly harder choices, increasing voter resentment as promises won’t be delivered, at least not without division and sacrifice along the lines of income.
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*The catchphrase was widely used in Bill Clinton’s the 1992 election campaign. Incumbent President George Bush, a war veteran, former Vice President and victor of the war in Iraq and the Cold War, was defeated to upstart Bill Clinton, who emphasised the economy. To this day it signifies the importance of economic realities as a factor in making political choices.
** I have often said that electoral gambits seldom play out. In the case of both Mr Sunak and Mr Macron, they seem to have done so. Mr Macron sacrificed stability to thwart Ms LePen, and this seems to have worked, even at great cost. In the UK’s first-past-the-post system, Reform overtaking Conservatives could have led to a Tory electoral wipe-out, for the first time since the rule of William Pitt the Younger (1780s), as every seat could be in danger even for a few votes. Mr Sunak ended his stint as Prime Minister a few months earlier than anticipated, simply to avoid that outcome and give his party a few years -instead of months- to fight off Reform. I wonder whether their “success”, pyrrhic to be sure, will encourage other leaders to take similar gambits, leading to more political and financial volatility, if for no other reason than to save moderate politics from the angry fringes.