Where are the markets?

[Sheilbh]

Okay this is stolen from a throwaway remark on a podcast which I've been obsessing over since and is a question for Minsky etc.

Where have the markets gone?

What I mean is that in the past "the markets" would through the bond and currency markets would respond to governments. This was normally interpreted as imposing some sort of discipline on those governments for whatever reason.

But there's the persistently low interest rates and the current examples of the US and the UK which are not getting the sort of response I think we'd expect in the past.

So to take the US: the President's an enormous tax cut that has significantly boosted the deficit in peacetime and, at the time, in the middle of a period of growth. He's also started a trade war with big chunks of the world either by hiking tariffs on China or harming trade negotiations. And he's currently engaged in an ongoing conflict/war of words with the "boneheaded" Fed that he appointed for not following the monetary policy he wants.

Despite this interest rates are still very low, there's no market discipline being imposed, it's not really causing much fluctuation (despite causing a real slowdown in growth) and the only change that seems to happen is in the currency markets. I can't think that if you had that sort of fact pattern in the first three years of, say, a Clinton or a Reagan administration there'd be severe, strong reactions that would impact politics.

Similarly in the UK, I can't think of a period in our post-war history where the Brexit policies and mitigants (or not real mitigants) would not have caused a severe shock. But we are able to carry on fumbling and failing without a market response that affects politics.

The only exception I can think of is leaving the Eurozone. So is it just that the markets will now take anything except redemonination of debt?

Or is it wider? Was "market discipline" a part of the neo-liberal period that is no longer part of our global economy's structure? And why? Or is it something peculiar to this moment, and what?

(yours, confused....)

[Malthus]

This sounds like a job for The Minsky Moment! 

[Sheilbh]

This sounds like a job for The Minsky Moment! 

Was targeted - though others may have an idea.

But also I was just thinking: given Trump, given our approach to Brexit.....is it really so certain that a radical left government or even an incompetent left government (Corbyn ) would provoke some wild response?

[Syt]

This sounds like a job for The Minsky Moment! 

Quick, shine the NY Yankees symbol!

[The Minsky Moment]

Whenever there is bad economic news that would effect the global economy, the markets flood into US treasuries as the ultimate safe haven asset.  That can have seemingly paradoxical results - i.e. if Trump acts in a way that seems destabilizing, then even if that creates higher perceived risk for the US economy, which ought to negatively impact US assets, it also creates higher perceived risk globally, which benefits Treasury bonds as an asset class.  This odd dynamic has played out many times in the last 2 years.

The US fiscal position has had a market impact - a 2 percent rate on a 10 year seems really low (historically it is) but it's quite high compared to say -0.40% for Germany.  It's all relative.

The defining characteristic of the post 2007 global economy is the lack of inflationary pressure. Unless or until that risk returns, the markets aren't going to raise nominal interest rates very high.

[Sheilbh]

So the US (and UK?) (presumably partly adjusted by currency changes?) are still safe haven assets despite - well, everything?

[The Minsky Moment]

The US may not look as solid as it used to but it's all relative.  Neither China nor the EU look like pillars of strength and reliable prosperity right now either.  "Safe" haven money has to flow somewhere.

The UK is different - rates are probably low because of pricing in of recessionary risk and/ot shocks from Brexit.

[Sheilbh]

Okay. So the US is a safe haven.

But without inflationary pressure all other developed economies are having record low interest rates because they all face some degree of recessionary risk. There is still, what seems like a very narrow range from, say, Australia or France to the UK. Despite the fact that Australia and France politically are broadly "pro-growth" and the UK is largely self-harming with safety scissors.

So in this world with such low inflation is there basically no "market discipline" or economic reaction to politics, until there's a recession and people suffer. Which makes me wonder have we moved from a world where economics corrected politics to one where actually the correction will be politics correcting the economics (ie people indulge all sorts of nonsense, suffer a severe recession, elect the opposition to fix policy and return to growth)?

Do you think it would make any difference if, say, there was a radical left government? And presumably the risk of inflation from redenomination is why the correction still exists around politics to leave the Eurozone?

[Sophie Scholl]

The Global Economy is a suicide risk climbing a tower while the world seems determined to chant for it to climb higher and remove any obstacles in its way.  I'm sure this will work out fine though.

[crazy canuck]

This sounds like a job for The Minsky Moment! 

Quick, shine the NY Yankees symbol!

It worked!

[Iormlund]

The defining characteristic of the post 2007 global economy is the lack of inflationary pressure.

Are there any theories as to why this has been the case? Has the global economy simply been deleveraging for the past 10 years?

[The Minsky Moment]

A lot of questions Sheilbh not sure how to approach all of them.

I think we need to be clear about what "market discipline" is supposed to mean.  The markets always react to political developments but how that reaction occurs depends on context.
Carville invented the idea of a reified all-powerful bond market bullying the President but that was rhetoric not reality.
By present day standards, the 1990-91 era recession seems stagflationary, with inflation rates at 4-5%.  It's an era where most people still had searing memories of the more serious stagflations of the 1970s and Volcker's brutal purge of inflation. 
In 1992 and 1993, GDP growth recovered quite healthily.   Facing the prospect in late 1993 of a possible increase in federal deficit spending, markets had to assume a risk of inflationary overheating which would tend to cause the Fed to offset by raising rates.  The bond market was pricing in expectations of how the Fed would react to anticipated future developments.

That did sort of happen in 2018 with the 10 year rate drifting up most the year as the Fed shifted towards tighter policy in response to the deficit fueled Trump boomlet.  The 10 year rate rose from about 2.05% in Sept 2017 to over 3 percent by May of 2018 and peaked at about 3 1/4 in the fall - that's an increase of over 50%.  But inflation did not materialize and by this summer the downside risks in the real economy started to loom larger than fears about overheating.

[The Minsky Moment]

It's always dangerous to cast economics in terms of morality plays.  The virtuous and the abstemious are not always rewarded; the profligate are not always punished.  The long term can be awfully long.  The Venezuelan economy grew quite nicely during Hugo Chavez's first term; the Soviet Union posted impressive growth rates for quite a while.  Macri did the "right things" in Argentina but got little love for it; now he faces the grim and seemingly unfair task of coping with the market reaction to his expected deposition before it happens.

[Sheilbh]

I think we need to be clear about what "market discipline" is supposed to mean.  The markets always react to political developments but how that reaction occurs depends on context.

Thanks for the patience there's a lot of questions because I'm fumbling in the dark for my point.

So I suppose there are two things with it, which you've flagged. The first is a market reaction to political developments, which depends on context.

Then there's "market discipline" as an ideological concept, which maybe alters the politics and in turn actually affects the market reaction.

I take your point on there being a response in 2018. This may be because the new normal doesn't feel normal yet, or because of the lack of inflation and recessionary pressures. But I don't think there was a sense of a significant correction going on that percolated and affected - but I could be wrong.

I suppose what I'm wondering is: how many fundamentals can be challenged or eroded without a significant market reaction. Because without that there's no political content of "market discipline" (because the US is a safe haven, or because there's no inflation).

The one I find really striking, just because I was thinking about a UK election, is monetary policy. Who made monetary policy used to be a very political issue, until the 90s/00s and are we in an odd moment (Labour proposing People's QE, Trump attacking the Fed) or a long-term re-politicisation?

But part of that is because 20 years ago financial markets would have really constrained a President who massively increased the deficit, started a trade war with China then escalated and said the Europeans are even worse. When the currency markets responded, he then turns and says "well who's responsible for currency" and attacks the Fed. I supose what I wonder, is where is the breaking point - for the US.

And I think the same with the UK. We have on the one hand Corbynism and on the other hand this running farce of Tory management of Brexit and likelihood of no deal Brexit. I feel, and I could be wrong, that at any other point in our post-war history both of those issues, and the impact of them would be a real challenge in the markets for a government and probably cause a sterling crisis. We've got both as very real risks at the same time, but there's no financial market constraints of the kind that litter post-war British history. So again, where is the breaking point?

Or is the effect of the post-2007 global economy that the political possibilities (on all sides) for wealthy democracies are reaching out wildly from what was previously the case. Has the economy basically shifted so much that those market constraints on politics don't function anymore or is it just that in the new normal they're not strong enough to function as an ideological enforcer like "market discipline"?

And part of me wonders if we are moving to more politics, how equipped are we to have those political arguments on the economy around a more political, fluctuating trade policy and re-politicised monetary policy etc. Especially people who previously would have just relied on "market discipline".

Edit: And the other panic I have is our politics are a messand poisonous in the UK and US but so far in relatively benign circumstances. What happens if those relatively benign circumstances shift?

[Sheilbh]

Interesting article by Adam Tooze on coronavirus and the economy that slightly touches on the point I wondered about here. I think the sub slightly missed the point of his article though

Coronavirus has shattered the myth that the economy must come first
Adam Tooze
Since the 1990s, faith in 'the market' has gone unchallenged. Now even public shopping has become a crime against society
Fri 20 Mar 2020 12.49 GMT
Last modified on Fri 20 Mar 2020 19.19 GMT

The coronavirus shutdown of 2020 is perhaps the most remarkable interruption to ordinary life in modern history. It has been spoken about as a war. And one is reminded of the stories told of the interruption of normality in 1914 and 1939. But unlike a war, the present moment involves demobilisation not mobilisation. While the hospitals are on full alert, the majority of us are confined to quarters. We are deliberately inducing one of the most severe recessions ever seen. In so doing we are driving another nail into the coffin of one of the great platitudes of the late 20th century: it's the economy stupid.

Once upon a time we thought we knew what was up and what was down. According to the lingua franca of the 1990s, in the wake of the cold war, it was obvious that the economics were the fundamentals, and the rest followed. It was the west's economic success that felled communism. And the economy ruled not only over creaky communist dictatorships, it defined the scope of possible politics in democracies. Arguing against globalisation, Tony Blair insisted, was as absurd as arguing against the seasons.

Then came 2008 and we were left wondering who the economic masters of the universe actually were. It was followed by the extraordinary, politically induced catastrophe of the eurozone debt crisis, in which conservative fiscal populism and dogma – disguised as expertise – ruled over the need to ensure employment and grow the pie. Then in 2016 the UK referendum delivered a majority for Brexit in the face of predictions of economic disaster. Months later, Donald Trump, a narcissistic billionaire, was swept to power by working-class votes in the face of opposition by the great and the good. Both the UK and the US have since pursued policies of spectacular economic irrationality without fear of a crushing veto by the markets. Liberal elites waited in vain for the market vigilantes to arrive.

And now Covid-19. Imagine if blunt economic interest was, in fact, dictating our response. Would we be shutting the economy down? What we know about the virus tells us that it most often kills what are by the numbers the "least productive" members of society. The majority of the working population experience symptoms barely more significant than a regular flu. Unlike regular flus it does not threaten children, the future workers. The virus may be bad, but simplistic economic logic would dictate that until we have a vaccine it would be best to keep life going, because, you know, "it's the economy stupid".

That was indeed the first reaction of the British government. The headline was that Britain was staying open for business. Journalists with good memories dug up Boris Johnson's fondness for the mayor in Steven Spielberg's Jaws who insists that despite the fact that a sea monster is eating his constituents the beach should stay open. The higher wisdom of public health, we were told, was that the productive workforce would acquire immunity. We know how that bold experiment in heroic economism has ended: a panic-driven withdrawal in the face of the disastrous scenario of hundreds of thousands of excess deaths, overwhelmed NHS hospitals and a crisis of political legitimacy.

It suddenly became obvious that when matters of life and death are concerned the calculus is different. Of course, old and sick people die. We all will in due course. But it matters fundamentally how and under what circumstances. A huge surge in mortality, even if it is limited to "vulnerable" populations with pre-existing conditions, is existentially unsettling. So too are the apocalyptic scenes that will unfold in our hospitals. In an earlier age, they might have remained behind a decent veil of obscurity. (No doubt the NHS and the BBC will work out the protocols for "embedded" reporting from the clinical frontlines.) But the words and images that have already come to us from northern Italy and Wuhan are bad enough. Faced with all of this, the stupidity lies in not recognising promptly that we must act, that we must shut down, that even the most essential individual activity of the market age, public shopping, has mutated into a crime against society.

This is not to say that economics is not shaping the crisis. It is the relentless expansion of the Chinese economy and the resulting mix of modern urban life with traditional food customs that creates the viral incubators. It is globalised transportation systems that speed up transmission. It is calculations of cost that define the number of intensive-care beds and the stockpiles of ventilators. It is the commercial logic of drug development that defines the range of vaccines we have ready and waiting; obscure coronaviruses don't get the same attention as erectile dysfunction. And once the virus began to spread, it was the UK's attachment to business as usual that induced fatal delay. Shutting down comes at a price. No one wants to do it. But then it turns out, in the face of the terrifying predictions of sickness and death, there really is no alternative.

It is once you have overcome that political, intellectual and existential hurdle – to realise that this is a matter of life and death – that economics enters back in. And it does so with a vengeance. The logic revealed by the well-organised Asian states is that it is best to conduct a severe quarantine regime in the hope of being able to return to normal activity as soon as possible. The Chinese economy is already resuming step by step.

In the west, the scale and breadth of the epidemic is such that our response now will have to be a blanket shutdown. And that begs gigantic questions of economic management. Even conservative governments on both sides of the Atlantic are pulling every lever of monetary and fiscal policy. In a matter of weeks they have embarked on gigantic interventions on a scale comparable to those in 2008. They may be able to soften the blow. But it is an open question how long we will be able to persist, how long we will be able to freeze the economy to save lives.

In making the difficult choices that lie ahead we have at least gained one degree of freedom. The big idea of the 1990s that "the economy" will serve as a regulating superego of our politics is a busted flush. Given the experience of the past dozen years we should now never tire of asking: which economic constraints are real and which imagined?

• Adam Tooze directs the European Institute at Columbia University and is the author of Crashed