Steen's Chronicle: welcome back to the 1970s

I bring you the story because Astrid Lindgren's main argument with the government was the overreaching power of government to not only tax her, but to decide everything. Pomperissa in the book exclaims: "102%, that’s not even possible". Well I think the lesson over the last two months is that everything – literally everything – is possible.

Over the last couple of months we have seen austerity abandoned, central banks losing independence, fiscal rules in the EU out the window, infinite QE all around the world, an explosion of the Fed’s balance sheet to bail-out Wall Street and high risk corporate debt, billions extended a bit less efficiently to bail-out Main Street, an introduction through the back door of Universal-Basic-Income (grants), Modern Monetary Theory (Monetizing debt of government through central banks balance sheet expansion). The most aggressive actor in all of this, the US Federal Reserve under Chairman Powell has ripped open swap lines to global central banks and in some of its more creative moves has violated the Federal Reserve Act by by using SPV's, yes that old chestnut, to "make everyone whole". 

The make everyone whole argument is a descent into terrible moral hazard, as we now not only abandon price discovery, but also the market based economy. This bailout means that airlines executives who left no cash on their balance sheet, and who allotted themselves 100 of millions of stocks in options through depleting the same balance sheet with massive stock buy-back programs. Or take IBM, which has spent $157 billion worth of stock last ten years but has a current market cap of $102 billion. Maybe we need to call on another Scandinavian author – the Danish H.C Andersen and his fairy tale of "The Emperor’s new clothes” – to fully understand what is going on.

The infinite support in all shapes and forms means we now have paradigms and business models which should not be possible: Negative Interest Rates, being paid to borrow money, and even this week, negative oil prices, or being paid to consume fossil fuel. I could try to explain why everything is at it is, but the task is simply too tall, because it just doesn’t make any sense. Sure, I can come up with a “talking head” explanation, but this market environment is simply too nonsensical to understand.

What is clear though is that both negative yields and negative oil prices are a function of 'Pomperissa in Monismania' - government and central bank policy overreach. Government has replaced markets in determining prices and therefore supply and demand. Oil got too cheap – and briefly negative because of the "free ride" enjoyed by oil producers in subsidies and mal-investment inducing low interest rates. This "support" kept marginal operators pumping oil despite never having realized a positive cash flow, even when oil prices were much higher. Simply put, oil prices have now also reached the zero bound as well and more importantly, as my friend Mark Voller told me this week, we now have 'liquid, but insolvent companies' operating in all sectors but in particular in the ones with big jobs, big investments and of strategic importance. Welcome to Monismania!

The 1970s started with big government and a strong USD and saw the USD weaken all decade and then high inflation and high unemployment after Nixon depegged the USD from gold in 1971. Marring the decade were supply constraints and terrorism. Geopolitics saw the enlargement of the EU, the opening up of China. Environmental policy crept up on the radar for the first time. 

And now? We have in my opinion gone full circle over the last 50 years and learned absolutely nothing. The first Earth Day was exactly 50 years ago today, and the environment is an even bigger issue today with our ever more anthropocentric world view, China is at risk of being "cut off", the USD is very strong and is still the world’s reserve standard – a standard the world desperately needs to de-peg from as the US Fed and government have decided to pay anyone holding US debt with IOU's based on printing money. EU membership has peaked will most likely be reduced again (Who will be first, Hungary?, Italy?).

Inflation is still lacking despite the desperate policy attempt to “achieve 2%”. But the bottlenecks and real capital destruction this crisis has created, together with infinite spending and grants to make everyone whole will see inflation returning again with a vengeance, sometime in the next two years. Unemployment is hitting 20% or worse in the US, and it will eventually fall, but 100-million plus American families have been impacted for this "inconvenience" here and now, and the UBI-type programs will act a bit like old trade unions did by requiring companies to bid up labor costs to get people to work any job. In short, welcome back to the 1970s.

What however concerns me more than the resonance with the setup in the 1970’s is that other aspects of our current situation remind me of the Post World War One time-frame. This was the last time we saw truly massive sovereign debt failures. This time around, Ecuador has already declared bankruptcy, African nations have received an eight month moratorium and Argentina has declared its own moratorium and told creditors to get lost. In the Middle East Oman and Bahrain are  effectively shut out of the bond market and are seeing their CDS prices (default insurance) rise and rise.

To understand the true impact of debt and potentially failed debt, read this article on how the UK only a few years ago repaid the last debt from that era, with Germany doing so in 2010 and the US still "making everyone whole" (Though I am sure Fed is ready to print some more money to help out.) 

The two tables below are from Sovereign-debt relief and its aftermath: The 1930s, the 1990s, the future? by Carmen Reinhart, Christoph Trebesch, 21 October 2014