Monday, 17 October 2016

Theresa May and the Strange Death of Free Markets (Part IV - Finance)

Theresa May's barnstorming populist turn has coincided with two curious phenomena: 

One has been increasing public scepticism at Quantitative Easing or QE (the expansion by Central Banks of the size of their balance sheets through the acquisition of assets with long term maturities - a.k.a. money printing). 

The other has been the descent of neo-Keynesian European federalists into the most unlikely hand wringing about the post-Brexit slide in the value of Sterling. 

The latter is more than a little amusing. Firstly, as I've already opined, the real cause of Sterling's drop has been that the UK's nearly 6% current account deficit, which is indicative of Sterling's traded value being a function of a Sterling asset bubble (which a cursory glance at the website of London estate agents evidences rather well). Brexit merely drew attention to this bubble and pricked it, hence Sterling's post-Brexit slide. Secondly, the likes of Jonathan Friedland, Gideon Rachman and George Osborne seemed strangely unconcerned at Sterling's QE-induced collapse in 2008. These people supported QE but opposed Brexit, leading to the inevitable conclusion that they have simply jumped on the falling Pound as a stick to beat Leavers with. This impression has been confirmed by Bank of England Governor Mark Carney's policy response to Brexit. If the fall in the Pound were a genuine top priority of the pro-Remain establishment, they would presumably have followed Sir Geoffrey Howe's early 1980s lead of jacking up interest rates and shrinking the BoE balance sheet in order to counteract the downward pressure on Sterling. Instead, Mr. Carney showed his true priorities by instituting subprime interest rates and more QE (i.e. the British establishment is so concerned at the fall in the Pound, that it decided to devalue it further).

The basic economics are simple enough. When your currency is overvalued, you can allow its value to fall to its true level or you can reduce its supply and increase the policy interest rate in order to raise its true value to its market value. The latter, which would increase interest rates for savers and make government borrowing less affordable, would be my preference. However, if this is politically unfeasible (and alas, it is) devaluation is the solution. The Sterling bubble allowed the Bank of England to have it both ways: higher asset and property values; cheap credit for borrowers (including the deep in the red UK government); and low inflation (due to the Pound not falling to its true value). Of course, as Ireland's IMF bailout administrator Ashoka Mody and Mr. Carney's much more sensible predecessor Mervyn King have pointed out, an overvalued currency has given the UK economy a form of Dutch disease, which has made Britain's export manufacturing extremely uncompetitive. What the falling Pound means is that air is released from the London bubble to the relief of Britain's regional manufacturing economy. It's funny how the Guardian extolled the virtues of transferring wealth from London to Britain's hard pressed regions... until it actually happened.    

QE and bailouts lie at the heart of how Britain's (and the world's) financial elite cherry picked their favourite elements of socialism and the free market; demanding and getting the freedom to speculate wildly on the asset markets, all the while receiving bailouts when it all went wrong in 2008 and QE and zero interest rates thereafter. These policies had the effect of inflating a new bubble in assets. This bubble included a dramatic chain selling of public debt, which has allowed insolvent governments to keep spending money like it's still 1999. Locked in this ironic embrace has been the financial services sector which has richly creamed off gains from this monetary expansion. Meanwhile, political uncertainty (especially in the Eurozone) has led to a flight of capital into Sterling assets which has sterilised inflationary effects and added to the bubble expansion.  Outside of the elite, the public sector and the welfare-addicted underclass, the returns were negative.

The cost of housing in prosperous conurbations like London and the stockbroker belt rose dramatically and exiled middle income earners to the exurbs. For those outside the big cities, QE, ZIRP and bailouts have done nothing to raise real business investment. Meanwhile, the overvalued Pound which has allowed this bubble to inflate unchecked made manufacturing uncompetitive, leading to stagnation in middle income jobs. For middle income savers who can't play the wild financial markets, the return on savings interest has been eviscerated by cheap money. Finally, the yield on Gilts and high quality bonds has become so low that private pension funds struggle to buy decent retirement annuities for people with private or occupational pensions. 

The UK government has spent the last eight years extolling the virtues of QE, whilst constantly repeating its fidelity to the free market which QE so horribly distorts. Mrs. May's volte face is stunning. In the same speech in which she abjured her party's traditional allegiance to the free market, she has begun to inch away from Central Bank monetary activism. Her assessment of the results of QE are indicative of this move:

"People with assets have got richer. People without them have suffered. People with mortgages have found their debts cheaper. People with savings have found themselves poorer."

In the long term, there can be no better way in which to resurrect the political viability of the free market than returning to the high interest rate and tight money policies so successfully deployed by Sir Geoffrey Howe and Paul Volcker in the early 1980s. Just as those policies slayed the demon of inflation in the 80s, today they can reverse the post-crisis trends of unaffordable homes, insecure retirements, stagnating wages, derisory savings interest, stagnant manufacturing and the upward redistribution of wealth. If she has the courage to follow through with her professed QE scepticism, both Sterling and the free market may have found an unlikely champion in Theresa May.

So, to conclude this series, if this is what passes for populism in 2016, then let's have more of it. Godspeed Mrs. May, Godspeed.  

Friday, 14 October 2016

Theresa May and the Strange Death of Free Markets (Part III - Immigration)

In Part II of this series, I analysed the 19th century time-warp in which 20th century trade policy interacted toxically with Keynesian monetary policy. A second key aspect of public discontent with globalism and the manner in which it has affected Theresa May's economically interventionist turn is immigration: in many ways, the sister issue of trade policy. Much like free trade, mass immigration has assumed a mystical emotional significance in elite and establishment thinking. Again, immigration represents what its proponents fail to either acknowledge or understand: a 19th century policy applied to a 21st century context and bounded by the restraints of a 20th century institutional architecture.

The only historic precedent for the scale of proposed immigration, the transformative capabilities of which are either blithely dismissed or heedlessly welcomed by elites, is a period that lasted from the mid-19th century as far as World War I. At the world's historic migratory peak, approximately a tenth of the world population lived outside their country of birth. The United States, Canada, Australia, New Zealand and other colonial or post-colonial territories accounted for the bulk of this migration. This great migration represents Exhibit A in the left's moral case for open borders, at least in the Anglosphere ("We are a nation of immigrants"). Meanwhile it represents Exhibit A in the free market right's economic case for immigration (the years 1850-1914 were extremely successful ones and it's unlikely that the great migration played no part in that era's economic expansion). However, before signing off on either the moral or the economic case for 1850-1914 Redux, we should perhaps take inventory of what was different about that economy to today's. Let me count those ways...

First, there's the quality of transport and communications. By today's standards, both were slow, unreliable, dangerous, inefficient and expensive. Steamships and transcontinental trains made it affordable for workers to make a once-in-a-lifetime trip to a different country. However, unlike today's airplanes and dry bulk carriers, they did not allow for daily and weekly goods shipments and business travel. If there was a mismatch between the demand for work product and the availability of workers to provide it, it was rarely economic to import the produce, leaving the importation of labour as the only alternative. This means that, all things being equal, globalised trade should logically reduce and not increase the organic market demand for immigrant labour. However, in an undistorted labour market of the type that largely existed in the 19th century, migration flows would self-regulate. The problem is that where the former doesn't exist, the latter isn't possible. Why?

First off, there's our old friend, the welfare state. In the 19th century, we didn't have one. Governments were not engaged in the business of wholesale fiscal transfer and the number of people consuming dramatically more government than they paid for in their taxes (or vice versa) was small. Today's western welfare states are largely funded by the top two quintiles of the earnings distribution, The benefit of government spending breaks disproportionately in favour of the bottom three quintiles. Meanwhile, the top quintile pays dramatically more than it receives (for example, 84% of US Federal Income Tax receipts come from the top 20% of taxpayers). In the 19th century, no immigrant who couldn't afford to finance his own housing, clothing, food and other basics could emigrate to a country and when he got there, neither he nor his employer could use the state to socialise any significant portion of his cost of living. Today, however, low skilled migrants are able to do precisely this. This alone massively undermines the financial viability of mass third world immigration. But if only this were the sole problem...

Because this neatly leads us into the third key dissimilarity between the economy of the 19th century and today's: regulation. In the 19th century, there was virtually no regulation of land use, building or labour. This meant that while jobs and housing were hardly infinitely available, there was no artificial government cap placed on their supply. By contrast, what the government regulates becomes more expensive and/or more scarce. What becomes more expensive will be used more sparingly and what becomes scarcer will become more expensive. What does this mean in practical terms? Minimum wage laws, unfair dismissals regulations, health and safety codes, anti-discrimination ordinances and other labour market impositions retard demand for labour. This means that when immigrants are admitted in circumstances in which there is no clear undersupply of labour (and there is no undersupply of unskilled workers in western countries), the inevitable result is that the heightened competition for a diminished pool of jobs results in higher unemployment and wage repression in lower skilled sections of the labour force. In the case of housing, planning and land use laws, zoning laws and building control regulations reduce the supply of housing and the basic economics of immigration are quite simple: more people = higher prices and higher rents.

Of course, the public policy elites don't want to hear any of this. On the left, mass third world immigration is basically seen as a mechanism for building a bigger market for the welfare state and a more left wing electorate. On the right, the influence of corporatist plutocratic lobbies who want cheap labour subsidised by the welfare state runs deep. That neither will get what they want hardly matters. They have made up their minds. The only dissenters from corporatist orthodoxy have traditionally been nationalists and free marketeers. Nationalism is in the ascendent: because of its toxicity to the donor class, it has been able to claim a monopoly over feelings of public discontent. This explains the rise of Donald Trump and why Nigel Farage (who is, at heart, a libertarian) has increasingly marketed his message in nationalist terms. But what of free marketeers?

In the 1970s, libertarian and conservative leaning free market advocates were willing to stand up to corporate lobbies. Most famously, Cato Institute co-founder William Niskanen was sacked as chief economist for Ford Corporation for refusing to advocate tariffs on Japanese motor vehicles. No more. Sadly, with some honourable exceptions, the think tanks that dominate free market advocacy have become gigantised and dependant on the very corporatist donor class they should be holding to account for their (lavish) funding. In 2013, the Heritage Foundation published a paper by Robert Rector and Jason Richwine in which they showed that the average illegal immigrant household received $14,387 more in government benefits than it paid in taxes. Once such households had their status legalised, the figure rose to approximately $28,000. For demonstrating that low skilled immigration represented a colossal, government subsidised drain on the native born, Rector, Richwine and Heritage, were rounded on by the other Washington think-tanks (even though none disputed their figures) and the unfortunate Richwine was forced to resign from his job over a confected controversy in relation to his Ph.D thesis.

Bottom line: economic liberalism has been bought while nationalism hasn't. If advocates of the free market want to influence canny political operators like Theresa May, they must find a way of un-buying themselves - or face the consequences.     

Sunday, 9 October 2016

Theresa May and the Strange Death of Free Markets (Part II - Trade)

For the last 30 years, the concept of free (i.e tariff-less and quota-less) trade across borders has maintained more or less total supremacy within the western political establishment. It was not always thus. In 1903, Joseph Chamberlain walked out of the Liberal Party in opposition to free trade. The Tory Party was firmly pro-tariff until after World War II. In the 1920s, the strongly laissez faire oriented Presidents Harding and Coolidge saw no problem with tariffs. In the 1980s, Ronald Reagan liberally applied tariffs against Japanese car manufacturers. Even as recently as 2001, George W. Bush imposed quotas on Chinese steel imports. Public discontent with free trade has, of course, been growing. John Kerry in 2004 and Mitt Romney in 2012 both adopted protectionist rhetoric when they challenged the incumbent presidents of their respective electoral cycles. However, they did nothing to challenge free trade as an orthodoxy. Not until Trump arrived on the scene this year did protectionism finally have a full-throated champion on a major party ticket.

Given the enormous philosophical strengths of free trade as a concept, it is tempting to denounce anti-trade sentiment as populist ignorance. But is it so? Sadly, behind the glitzy surface, the supposedly "ignorant" masses have a point. Supposed "free" trade has a squalid underbelly which is much more apparent in fading industrial towns in the American Midwest and the North of England than it is in the bustling finance hubs of the big cities. Unfortunately for the free traders, their influence was reaching its apogee at precisely the point in time at which the financial substratum of their entire concept was unravelling. To wit, free trade was a 19th century philosophy built in the days of fixed exchange rates and the gold standard. The likes of Smith, Ricardo and Bastiat had not reckoned with beggar thy neighbour currency devaluation or the use by Central Banks of currency as a tool of macroeconomic policy rather than as a medium of wealth storage and exchange.

The 20th century welfare state, with its incessant demands for government borrowing, destroyed the last vestiges of fixed exchange rates in the 1970s. Classical Central Banking was replaced with a Keynesian Central Banking structure whose role was to create inflation for the twin purposes of cutting real wages and inflating away government debt. The economy for which this policy was designed was an essentially closed one and, moreover, an economy in which socialist India and Communist China (and their billions of workers) were cut off from the rest of the world. In fairness to the designers of this inflationist monetary system, they did not envisage it operating in a free trade economy. Much like their teacher, Lord Keynes, they assumed that any distortions in trade caused by monetary policy could be addressed through tariffs or quotas. In a protected and largely closed economy, they reasoned, Central Banks could dial prices up as they wished by expanding monetary aggregates and cutting interest rates.

Whatever the (dubious) wisdom of this policy, it plainly did not envision a world of free trade with the gigantic labour forces of India and China now integrated into it. The China price of labour was able to aggressively compete with western manufacturing workers, while the India price of labour competed against lower end tech workers. The result was that as western Central Banks dialed up inflation, consumers were able to export some of that inflation by switching to Chinese and Indian imports. This meant that while upscale, professional workers who lacked Asian competitors were able to increase their earnings in line with inflation, middle income earners in manufacturing and tech were left either having to lose wage purchasing power in order to keep their jobs or unable to compete at all and seeing their jobs outsourced to China and India.

Of course, Chicago School-led reforms of the 1980s were supposed to make such a course of events impossible. In the pages of Milton Friedman's textbooks, free floating exchange rates would cause western trade deficits to put downward pressure on the value of western currencies, thereby making continued Asian imports unaffordable. Again, it was a respectable enough theory. However, Professor Friedman's textbooks always assumed that all Central Banks would adopt the same inflation targeting policies. Nowhere in the theory of floating exchange rates was there any explanation for what would happen when countries like China adopted a policy of fixing their exchange rates to the US Dollar. With Asian Central Banks buying every scrap of western debt they could lay their hands on in order to keep their currencies artificially cheap, "free" trade became a joke. Instead of using their foreign exchange reserves to buy western imports, as free trade theorists assumed they would, Asian governments lent them back to western borrowers so that they could sell even more manufactured goods.

Western economies slowly degenerated into permanent deficits and debt pyramiding. Within those economies, the distributional impacts were extremely lopsided. The West's poorest households enjoyed a bonanza of cheap clothing, footwear, toys, utensils and other consumer goods. The West's wealthiest households enjoyed the benefit of asset price increases and subsidies to their supply chains which allowed them to source the world's cheapest labour for their manufacturing needs. Those in the middle, however, were primarily rewarded with higher costs of housing, lower wages, poorer jobs and economic insecurity. With erosion of the western middle class and downward economic mobility between generations, cities like New York, London and Toronto increasingly became places in which it became impossible to live unless one was rich enough to afford grossly overpriced property or poor enough to qualify for fiscal transfers and subsidised housing.

Increasing resentment amongst middle income (and, in some cases, formerly middle income) voters has taken both the mainstream right and the mainstream left aback. The outsourcing of manufacturing and stagnation of median earnings has led to anti-rich sentiment. With the words "free market" having become a mantra (albeit an insincere one) of the prosperous classes, those locked out of the increasingly uneven spread of prosperity have translated their hostility to the fabled "1%" into anti-market sentiment. If this surprises true believers, it shouldn't. At the same time, the mainstream left has been taken aback at increasing resentment being directed against the economic underclass. Once again, they shouldn't be. Marxist theory sees "inequality" as the problem, full stop. However, ordinary voters seem to resent not the notion of wealth inequality per se, but rather, the notion that people are being allowed to drink water that they didn't carry. This is why left and right alike have been scratching their heads at phenomena such as Trump and UKIP; because while they represent class warfare, it is a form of class warfare which does not follow the early 20th century socialist playbook or a late 20th century Thatcher/Reagan one.

One way or the other, free marketeers need to lose their smugness and start to acknowledge that when it comes to trade policy, something has gone erratically wrong and that if they don't devise a solution, someone else will. 

Theresa May and the Strange Death of Free Markets (Part I)

Theresa May has made a truly fascinating start to her tenure as the UK's Prime Minister. In spite of having campaigned for her country to stay in the EU, she has taken to the cause of Brexit with gusto since assuming power. She has also confounded my earlier predictions in relation to her loyalties. While her statist economic instincts have not surprised me, the direction in which she has chosen to apply them has. As the wife of a wealthy banker with a history of recycling elite tropes about "modernisation" and the Tories being the "nasty party", I had little doubt that her passion for big government would follow the metropolitan track of her predecessor, David Cameron, with an emphasis on loose monetary policy and environmentalism. However, instead, we have seen a populist and nationalist turn, rejecting not merely libertarianism but also the corporatist globalism that has characterised her party since the 1990s. Perhaps the most significant passage in her speech reads as follows:

"Just listen to the way a lot of politicians and commentators talk about the public. They find your patriotism distasteful, your concerns about immigration parochial, your views about crime illiberal, your attachment to your job security inconvenient."

Or consider this:

"But if you believe you’re a citizen of the world, you’re a citizen of nowhere. You don’t understand what the very word ‘citizenship’ means."

In one fell swoop, May has done two things. Firstly, she has broken the consensus which has prevailed amongst western elites for at least the last 40 years: namely, that nations and borders are anachronistic and sectarian throwbacks to a primitive and unenlightened past. That any major party in a western country could be led by a person of distinctly national conservative views is astounding enough. That such views could be adopted by a quintessentially establishment politician who has risen to the highest office in her country without once having said or done anything that hints at such heresy is positively flabbergasting. If you want to understand the scale of May's rhetorical turn, just imagine Hillary Clinton being elected in November and then suddenly announcing that she agrees with Donald Trump on immigration, trade and globalisation. Yes, that is the extremity of the scenario that is currently unfolding.

The second thing May has done is to rhetorically ratify what has long since been the de facto reality of Tory politics, at least since Margaret Thatcher left office and perhaps earlier: namely, the abandonment of the free market. A May premiership seems to be resurrecting the pre-1975 model of Tory dirigisme: energy price controls; worker representation on corporate boards; the adoption of so called "industrial policy"; the unashamed use of the state to fight inequity; and the explicit denunciation of the libertarian right. This marks a similar sort of departure. While the economics of corporate globalism have been almost uniformly statist for at least the last 20 years, rhetorical fidelity to the free market has been religiously observed by the English-speaking right. In truth, compared to the extraordinary government interventions manifested by bank nationalisations, taxpayer bailouts of financial markets, massive scale quantitative easing (i.e. money printing), unprecedented Central Bank incursion into capital markets, zero and negative interest rates and the cap and trade emissions cartel, May's deviations from the free market are fairly modest.

Despite all the gnashing of teeth and wringing of hands, what is truly controversial about May's new direction is that unlike establishment-approved politicians like Barack Obama and Angela Merkel, she has suggested that her loyalty to her own fellow citizens exceeds her loyalty to the footloose and nationless global elites. Today's establishment will forgive politicians who heedlessly inflate financial bubbles, destroy whole countries with reckless foreign policy misadventures, or institute immigration policies which endanger the physical safety of western citizens (especially women). However, they will not countenance any leader who puts her own country first in public policy. To call Mrs. May brave is an understatement - regardless of whether she is sincere.

As a free marketeer whose political views would be roughly those described by Rand Paul as "libertarian-ish", I share in some of the dismay (no pun intended) of many commentators at May's interventionist lurch, not least because May's rhetorical turn against free enterprise, much like Tony Blair's rhetorical turn against socialism twenty years ago, seems to be indicative of the underlying dynamics of the public mood. What I do take issue with is the knee jerk condemnation of Mrs. May's new political direction. She is, after all, a politician and politicians always and everywhere seek to identify themselves with emerging trends in public sentiment. Clearly, Mrs. May has looked at a world of Trumps, Corbyns, Le Pens, Farages and Orbans and concluded that market-bashing is politically canny.

For those who believe, as I do, that market forces are, in the long run, better than government fiat in determining how resources should be allocated and distributed, the real question is why the public has lost faith in free enterprise The answer, in my view, lies in a toxic combination of trade, immigration and financial policy. My next few posts will focus on what has gone wrong and what can be done to rectify it.