Thoughts through the cycle: w4 November ’20

Share on facebook
Share on twitter
Share on linkedin

The Great Reset – great idea, great big price tag

  • In the era of fake news, sometimes it takes an historian to frame the debate around the issue of facts, events, sources and how they are combined to create a truthful account of affairs. ‘The Hitler Conspiracies’ by Richard J. Evans, Regius professor of History at Cambridge University, is one such work. With respect to the pursuit of the truth, historical or otherwise, Evans is beyond reproach – he was for example the expert witness for the defence in the defamation trial brought by the holocaust-denier David Irving in 1999. For those interested in that story, Mick Jackson’s 2016 film ‘Denial’ is an excellent introduction.
  • In Evans’ new book, amongst other things he examines how conspiracies often involve the creation of a causal relationship between apparently chance events and subsequent outcomes, especially if the latter are of great benefit to one particular group, based on the idea that something so beneficial couldn’t have happened just by chance, and therefore had to have happened by design. The example Evans uses is the Reichstag fire of February 1933 – the work of one individual unconnected to the Nazi party, but an event which allowed Hitler to suspend parliament and set Germany on the road to dictatorship. So convenient was this to Hitler that the left could not accept it was not a Nazi-orchestrated event, and from this view, a conspiracy grew.
  • So when Canada’s prime minister Justin Trudeau referred in a recent UN speech to the ‘Great Reset’ and then mentioned the plan to ‘build back better’ (a Biden campaign slogan subsequently co-opted by Britain’s Boris Johnson), the conspiratorial element of the twitter-sphere went into overdrive with the sad old meme about a global elite conspiracy to rule the world (“The baseless ‘Great Reset’ conspiracy theory rises again”, NY Times, 16/11/2020).
  • The origins of the expression ‘The Great Reset’ are fairly prosaic. Back in May 2020, Britain’s Prince Charles and Klaus Schwab, head of the World Economic Forum (WEF), announced a meeting for heads of state to discuss climate change and the rebuilding of the world economy following the Covid-19 pandemic. While the WEF is a supra-national body whose meetings are attended by heads of state, this doesn’t necessarily make it ‘shadowy’. In the more enlightened days in which we now live, one cannot be taken seriously if one characterises Herr Schwab as some sort of James Bond villain just because he is old, bald and has a German accent. Sadly, conspiracy thrives on crude stereotyping.
  • What does Herr Schwab stand for? In article for Project Syndicate (‘Post COVID Capitalism’, 12/10/2020), Schwab issues a broad-side on ‘Free-market fundamentalism’ and then demands a rethink of capitalism and the very meaning of capital:

‘But we must rethink what we mean by “capital” in its many iterations, whether financial, environmental, social or human. Today’s consumers do not want more and better goods and services for a reasonable price. Rather, they increasingly expect companies to contribute to social welfare and the common good. There is both a fundamental need and an increasingly widespread demand for a new kind of “capitalism.”’

  • One can see how Schwab’s tone could seem elitist. Exponents of the market such as Hayek would argue that only the individual knows what they want and any deviation from this restricts market economics and with it, individual liberty (cf. Hayek, ‘The Constitution of Liberty’, 1960 – the book incidentally which Margaret Thatcher once held up saying ‘this is what we believe in’). Schwab’s goal is as follows:

‘If the COVID crisis has shown us anything, it is that governments, businesses, or civil-society groups acting alone cannot meet systemic global challenges. We need to break down the siloes that keep these domains separate, and start to build institutional platforms for public-private cooperation. Equally important, younger generations must be involved in this process, because it is inherently about the long-term future.’

  • What does this all mean? This is clearly the call to arms for a green revolution of some sort, and one pursued on a global basis. Its collective and communitarian tone obviously goes against the unilateral tendencies of the US under Trump, and it suggests that the boundaries of the public and private are to be blurred for a common aim.
  • To the warped mind of a conspiracist, the 2020 Covid-19 pandemic has been a crisis orchestrated to effect a grab for power by a do-as-I-say-not-as-I-do global elite. For more normal people, it is best understood in more conventional terms, even if the real implications are dramatic. The US deficit is currently around 16%, and the increased bond issuance resulting from it is in part being absorbed by the domestic banks, but mainly through central bank quantitative easing (QE). Foreigners are buying relatively little (Chinese treasury purchases are falling). That is the mechanics of debt monetisation, and with the largest non-crisis deficit going into 2020, the US deficit dynamic is not changing any time soon. The point is it cannot – austerity (falling government spending) now would cause a deep recession.
  • The mechanism is only part of it. Yes, there has been a fiscal-monetary fusion in the US and elsewhere, and even if it is only de facto, it is a practical example of the spirit of modern monetary theory (MMT), where the only limit on government spending is inflation, and that tends to be a lagging not a leading phenomenon, and one which, when left unchecked, is not simply stopped by hiking taxes per the MMT-folk. Their logic is that tax stops spending, and this reduces inflation. Good luck with that. When you get real inflation, you usually end up having to get a new money system, or at least a new basis for it in terms of an interest rate policy that radically alters the long-term balance of society, much in the way the Volcker Fed of the early 1980s did with its aggressive rate hikes bringing to an end the great inflation of the 1970s.
  • That there has been a revolution can be seen in the fact that no one, perhaps with exception of a few lizard-brained denizens the US Senate, has been really opposed to any of the fiscal measures introduced during the pandemic. Furlough payments are necessary, government interventions on behalf of small businesses are lauded, tax hikes are being universally disavowed as dangerous to the nascent recovery and so on. In the UK, a Tory government has spent in a way which goes beyond the most diabolic claret-and-cheese-induced nightmare that any country squire might have had this time last year as Corbyn’s Labour party took a tilt at power.
  • This is where our conspiracy theorists are wrong. There is a well-known trend with respect to government and power that the temporary tends to become permanent. On a grand scale, this is why the developed world was unable after the first world war to return to the classic gold standard, and why the shift toward a fully-fiat money system proved inexorable. To fight that war, governments had to mobilise national resources to a previously unimaginable extent. Once over though, the sinews of power remained, and were exercised, not least because of the social changes unleashed by the war itself, notably the slow social and political drive towards a welfare state and the like. With central banks co-opted into government financing, one can assume that the build back better and green revolution are merely policies which can now be implemented as a result of powers used and retained from the pandemic. As with the Reichstag fire, a chance event has provided the catalyst for this permanent change in the role of government.
  • From a moral perspective though, the green revolution is a million miles from the Nazi seizure of power. On the contrary, it is perhaps only from catastrophic events that sufficient political and social will can be garnered for change, and given what we now know about climate change, perhaps now is the moment for words to become deeds. In the UK, PM Boris Johnson’s announcement of a £12bn green revolution plan has immediately been criticised by opposition parties as too feeble, with France’s €30bn and Germany’s €40bn plans cited in comparison (‘Johnson’s green promises judged too meagre for net zero target’, FT, 19/11/2020). From a ‘no planet B’ standpoint, the bill is going to be large, and there is arguably a moral imperative that it be paid. This should be the starting point for all investment decision-making and asset allocation going forward, as it recognises not only that this thing is going to happen because governments can do it, but that there is largely a consensus that it should be done, and that doing it will help the recovery from pandemic. Let it be.
  • The last time countries acted like this was in the second world war. Britain, for example, bankrupted itself in the process, but there can be no question that despite the losses of blood and treasure, the stand against Nazi Germany was not only right but also morally imperative, and the nation’s pride in its achievement still resonates today. The transformation of the global economy to eliminate fossil fuels and to limit the negative effects of climate change on the environment is the sort of cause that many now feel is worth the cost. From an investment point of view, there is the question of capital allocation towards these ends, something which generally falls under the ESG banner but also goes beyond it. The lesson of Britain’s decline should be a key one for long-term asset allocation. While the effort may be just, investors ought to be looking for a way to mitigate the cost burden while allocating capital to effect the worthy outcome.
  • How was the second world war funded? In the US, it was through debt, and this was monetised through financial repression via the control of interest rates by the Fed. Interest rates were set at 0.875% at 1yr, 2% at 10yr, and 2.5% on the long bond. Real rates went deeply negative. The graph below (courtesy of Tradingeconomics.com and the US Bureau of Labor Statistics) shows the staggering inflation levels reached in the 1940s, with a 20% peak eating the inflationary lunch of the 1970s and 1980s. The use of yield curve control (YCC) is something the Fed is talking about – not actively considering, but at least acknowledging should the desired fiscal stimulus demand its implementation. The market should require no more warning about the likely direction of travel. With a Biden White House, it is likely that policy will start to move that way, if not through Congress then by executive order and all the funnies that come with that.

Source: Tradingeconomics.com, 31 October 2020.

  • Should there be any lingering doubt about what is coming, then one ought to refer to central banks themselves. The important ones (Fed, ECB, BoE) are talking about the limits of monetary policy at or below the zero bound for fiscal policy to do the heavy lifting, especially green spending. Cheerleader-in-Chief here is Mark Carney, former governor of the BoE. Former Fed chair Yellen is apparently in the running as Biden’s Treasury Secretary – her appointment would mark a symbolic fusion of the Fed and Treasury, if not in law but in spirit.
  • The final element of the equation is the wide-spread discussion of central bank digital currencies (CBDCs). China is leading the way, but the other G7 central banks are very much working on the project. The most recent update comes from BoE chief economist Andrew Haldane (‘Negative interest rates could encourage digital currency, says Haldane’, The Times 19/11/2020):

“What I am discussing here is a structural shift in the monetary regime and carries no implications for the costs and benefits of negative interest rates in the shorter term…Nonetheless, I believe it is important that these potentially large macroeconomic benefits of a digital currency are explored when evaluating the case for a new monetary order…The three Rs – recovery, rebalancing, revitalisation – are more important than ever. So too is the need for optimism about the opportunity this crisis will serve up, as all crises do.”

  • No mention of the fourth R, “Reset”, but perhaps Mr Haldane is social media savvy enough to avoid that naughty word which caused so much Twitter rage when the Canadian prime minister used it. A digital currency is a means by which government can simply ‘put’ money in people’s (and companies’) bank accounts. It is a means of getting money to people quickly, much more quickly than the donkey system of cheques the US used earlier this year with its $1,200-per-person pandemic hand out. It’s not that it’s coming, it’s happened – they just want to make the means of delivery more efficient.
  • Global digital currencies, deeply negative rates – not dissimilar to the US in the 1940s – effected by financial repression, and wartime spending plans, with the war this time on climate change as well as inequality and other things. Chances are all that is going to be a bit inflationary, wouldn’t you say?
  • The investment world is carrying on as though the vaccine means the world will go back to the way it was.
  • The reality is going to be different. The clock hasn’t been stopped or turned back, it has moved on, and with it, the asset allocation process needs to change and adapt not only to be congruent with the goals of the green revolution and build back better, but to protect investors where possible from the price of glory, as that price is probably going to be a pretty steep one, however worthy the outcome.

The names shown above are for illustrative purposes only and is not intended to be, and should not be interpreted as, recommendations or advice. No investment strategy or risk management technique can guarantee returns or eliminate risks in any market environment.

Unless otherwise stated, all opinions within this document are those of the RWC Diversified Return Investment Team, as at 26th November 2020.

The term “RWC” may include any one or more RWC branded entities including RWC Partners Limited and RWC Asset Management LLP, each of which is authorised and regulated by the UK Financial Conduct Authority and, in the case of RWC Asset Management LLP, the US Securities and Exchange Commission; RWC Asset Advisors (US) LLC, which is registered with the US Securities and Exchange Commission; and RWC Singapore (Pte) Limited, which is licensed as a Licensed Fund Management Company by the Monetary Authority of Singapore.

RWC may act as investment manager or adviser, or otherwise provide services, to more than one product pursuing a similar investment strategy or focus to the product detailed in this document. RWC seeks to minimise any conflicts of interest, and endeavours to act at all times in accordance with its legal and regulatory obligations as well as its own policies and codes of conduct.

This document is directed only at professional, institutional, wholesale or qualified investors. The services provided by RWC are available only to such persons. It is not intended for distribution to and should not be relied on by any person who would qualify as a retail or individual investor in any jurisdiction or for distribution to, or use by, any person or entity in any jurisdiction where such distribution or use would be contrary to local law or regulation.

This document has been prepared for general information purposes only and has not been delivered for registration in any jurisdiction nor has its content been reviewed or approved by any regulatory authority in any jurisdiction. The information contained herein does not constitute: (i) a binding legal agreement; (ii) legal, regulatory, tax, accounting or other advice; (iii) an offer, recommendation or solicitation to buy or sell shares in any fund, security, commodity, financial instrument or derivative linked to, or otherwise included in a portfolio managed or advised by RWC; or (iv) an offer to enter into any other transaction whatsoever (each a “Transaction”). No representations and/or warranties are made that the information contained herein is either up to date and/or accurate and is not intended to be used or relied upon by any counterparty, investor or any other third party.

RWC uses information from third party vendors, such as statistical and other data, that it believes to be reliable. However, the accuracy of this data, which may be used to calculate results or otherwise compile data that finds its way over time into RWC research data stored on its systems, is not guaranteed. If such information is not accurate, some of the conclusions reached or statements made may be adversely affected. RWC bears no responsibility for your investment research and/or investment decisions and you should consult your own lawyer, accountant, tax adviser or other professional adviser before entering into any Transaction. Any opinion expressed herein, which may be subjective in nature, may not be shared by all directors, officers, employees, or representatives of RWC and may be subject to change without notice. RWC is not liable for any decisions made or actions or inactions taken by you or others based on the contents of this document and neither RWC nor any of its directors, officers, employees, or representatives (including affiliates) accepts any liability whatsoever for any errors and/or omissions or for any direct, indirect, special, incidental, or consequential loss, damages, or expenses of any kind howsoever arising from the use of, or reliance on, any information contained herein.

Information contained in this document should not be viewed as indicative of future results. Past performance of any Transaction is not indicative of future results. The value of investments can go down as well as up. Certain assumptions and forward looking statements may have been made either for modelling purposes, to simplify the presentation and/or calculation of any projections or estimates contained herein and RWC does not represent that that any such assumptions or statements will reflect actual future events or that all assumptions have been considered or stated. Forward-looking statements are inherently uncertain, and changing factors such as those affecting the markets generally, or those affecting particular industries or issuers, may cause results to differ from those discussed. Accordingly, there can be no assurance that estimated returns or projections will be realised or that actual returns or performance results will not materially differ from those estimated herein. Some of the information contained in this document may be aggregated data of Transactions executed by RWC that has been compiled so as not to identify the underlying Transactions of any particular customer.

The information transmitted is intended only for the person or entity to which it has been given and may contain confidential and/or privileged material. In accepting receipt of the information transmitted you agree that you and/or your affiliates, partners, directors, officers and employees, as applicable, will keep all information strictly confidential. Any review, retransmission, dissemination or other use of, or taking of any action in reliance upon, this information is prohibited. The information contained herein is confidential and is intended for the exclusive use of the intended recipient(s) to which this document has been provided. Any distribution or reproduction of this document is not authorised and is prohibited without the express written consent of RWC or any of its affiliates.

Changes in rates of exchange may cause the value of such investments to fluctuate. An investor may not be able to get back the amount invested and the loss on realisation may be very high and could result in a substantial or complete loss of the investment. In addition, an investor who realises their investment in a RWC-managed fund after a short period may not realise the amount originally invested as a result of charges made on the issue and/or redemption of such investment. The value of such interests for the purposes of purchases may differ from their value for the purpose of redemptions. No representations or warranties of any kind are intended or should be inferred with respect to the economic return from, or the tax consequences of, an investment in a RWC-managed fund. Current tax levels and reliefs may change. Depending on individual circumstances, this may affect investment returns. Nothing in this document constitutes advice on the merits of buying or selling a particular investment. This document expresses no views as to the suitability or appropriateness of the fund or any other investments described herein to the individual circumstances of any recipient.

AIFMD and Distribution in the European Economic Area (“EEA”)

The Alternative Fund Managers Directive (Directive 2011/61/EU) (“AIFMD”) is a regulatory regime which came into full effect in the EEA on 22 July 2014. RWC Asset Management LLP is an Alternative Investment Fund Manager (an “AIFM”) to certain funds managed by it (each an “AIF”). The AIFM is required to make available to investors certain prescribed information prior to their investment in an AIF. The majority of the prescribed information is contained in the latest Offering Document of the AIF. The remainder of the prescribed information is contained in the relevant AIF’s annual report and accounts. All of the information is provided in accordance with the AIFMD.

In relation to each member state of the EEA (each a “Member State”), this document may only be distributed and shares in a RWC fund (“Shares”) may only be offered and placed to the extent that (a) the relevant RWC fund is permitted to be marketed to professional investors in accordance with the AIFMD (as implemented into the local law/regulation of the relevant Member State); or (b) this document may otherwise be lawfully distributed and the Shares may lawfully offered or placed in that Member State (including at the initiative of the investor).

Information Required for Distribution of Foreign Collective Investment Schemes to Qualified Investors in Switzerland

The representative and paying agent of the RWC-managed funds in Switzerland (the “Representative in Switzerland”) is Société Générale, Paris, Zurich Branch, Talacker 50,

P.O. Box 5070, CH-8021 Zurich. In respect of the units of the RWC-managed funds distributed in Switzerland, the place of performance and jurisdiction is at the registered office of the Representative in Switzerland.

Explore more

Thoughts through the cycle: W2 January ’21

In a fragmentary work on the philosophy of psychology published in 1953 after his death, Ludwig Wittgenstein addressed the phenomenon of how our impressions of what we see…

INVESTOR TYPE SELECTOR

Please confirm your investor type

Professional

Non-professional

By clicking Submit, you agree that you have read and accepted the terms and conditions detailed in the DISCLAIMER

This website uses cookies. A cookie is a small data file placed on your computer which captures information about your choices which allows us to improve your experience of the website, for example, by remembering your country of residence. By continuing to access this website, you agree to be bound by our Cookie Policy. You can accept and/or block at any time by changing your browser settings.

SELECT YOUR REGION

Where are you located?

Europe

Asia-Pacific

Rest of world

By clicking Submit, you agree that you have read and accepted the terms and conditions detailed in the DISCLAIMER

INVESTOR TYPE SELECTOR

What type of investor are you?

Professional

Non-professional

By clicking Submit, you agree that you have read and accepted the terms and conditions detailed in the DISCLAIMER