Speaker 1: Welcome to Covid Time, a podcast series on markets and
Speaker 1: economies from DBS group research. Chief economist. Welcome to our
Speaker 1: 86 episode. Today's guest is David. Marsh. David. Co founded
Speaker 1: in 2009 official monetary and financial institutions forum. Better known
Speaker 1: for its acronym AMF if it's an independent think tank
Speaker 1: for central banking, economic Policy and public investment. Since 2018,
Speaker 1: David has served as office chairperson
Speaker 1: before setting up this think tank. He worked for city
Speaker 1: merchant bank robert, Fleming corporate finance, boutique, Hotpoint, german management consultancy,
Speaker 1: droga investment from London, Oxford and many other places, including
Speaker 1: almost two decades in journalism spending most of that time
Speaker 1: with the Financial Times. David has written six books, the
Speaker 1: last of which is co authored with William keegan and
Speaker 1: Richard roberts is titled Six Days in september black Wednesday
Speaker 1: Brexit and the making of europe.
Speaker 1: I think, given what has transpired lately, David, that book
Speaker 1: needs an additional chapter. Welcome to Covid Time. David.
Speaker 2: Thank you. Good to be with you.
Speaker 1: It is a pleasure to have you, David. Let's start
Speaker 1: with the very latest and with the caveat that both
Speaker 1: you and I recognize things can turn stale between the
Speaker 1: time we record this and the time it comes out,
Speaker 1: the sterling crisis. David back in 92 had the pound
Speaker 1: correcting by about 29% against the us dollar.
Speaker 1: The latest episode of sterling weakness has transpired over a
Speaker 1: longer period of time, much slower moving train wreck if
Speaker 1: you will, but the adjustment hasn't been trivial either. Almost 25%
Speaker 1: from peak to trough. I have a few questions on
Speaker 1: the ongoing episode for you first, your assessment on the
Speaker 1: policy actions and the economic conditions that have led to
Speaker 1: such massive depreciation of the sterling,
Speaker 2: The whole world is in a mess. And we have
Speaker 2: a very strong dollar. That's the backdrop. 1992, we had
Speaker 2: a relatively weak dollar. That was one big contrast this
Speaker 2: time around. The government's failings have been very, very palpable
Speaker 2: in the UK. They were
Speaker 2: We're, of course, also evident in 1992, that was a
Speaker 2: failure of judgment about when to go into the exchange
Speaker 2: rate mechanism. I think that the misjudgments and the pure
Speaker 2: incompetence this time around has been actually much worse than
Speaker 2: in 1992. Also, the government was warned the mistress's government
Speaker 2: and only a short time in office was warned before
Speaker 2: the so called Mini budget on 23 September that this
Speaker 2: could lead to a big market problem.
Speaker 2: They were told by advisers in writing that they would
Speaker 2: need to watch out about the market reaction, but they
Speaker 2: were arrogant about this and they failed to take onboard
Speaker 2: those warnings. So some of this is part of the
Speaker 2: general rather difficult background we have with the Russian war
Speaker 2: and the strong dollar, but I would say 80% of
Speaker 2: this is a self inflicted wound.
Speaker 1: And you place the blame with the Prime Minister's office
Speaker 1: and the Treasury? What about the Bank of England and
Speaker 1: its role. Is it like going on the opposite direction.
Speaker 2: There are strong signs that there are strong conflicts between
Speaker 2: the Bank of England and the Treasury and the prime minister.
Speaker 2: And this is not good news in a crisis. And
Speaker 2: we learned that in 1992 and in many other cases,
Speaker 2: there was actually a surprising amount of coordination in nine
Speaker 2: United Two between the Bank of England and the Treasury.
Speaker 2: This time, Liz Truss has been riding roughshod over some
Speaker 2: of her advisers. She caused the main official in the
Speaker 2: Treasury Sir tom Scholar, to be sacked on day one
Speaker 2: of her tenure.
Speaker 2: This is unprecedented. That this was at the beginning of
Speaker 2: september normally, if Prime Ministers don't like the top civil
Speaker 2: servant in the treasury, they find a way of just
Speaker 2: lodging that person over time, but not on day one,
Speaker 2: This was two days before the queen died. And so
Speaker 2: it added to the sense of great
Speaker 2: Change and dislocation at the Bank of England just a
Speaker 2: day ago. From the time when we're doing this podcast
Speaker 2: did issue a very strong statement about the reasons why
Speaker 2: it brought in this emergency action which took place at
Speaker 2: the end of September the famous shoring up of the
Speaker 2: Gilts market and it justified this action on the grounds
Speaker 2: that they would otherwise have been a huge dislocation with
Speaker 2: pension funds, about 50 billion
Speaker 2: sterling worth of gilts had it not been for the intention,
Speaker 2: which they made saying that they would buy up to
Speaker 2: five billion of guilt today over 13 working days. That
Speaker 2: will run out on the 14th of october and they're
Speaker 2: really staying in that letter and there's very strong divergence
Speaker 2: between what the treasury is doing under its new leadership,
Speaker 2: basically led by truss and the quasi tang the new
Speaker 2: charts of the exchequer and the bank itself. So this
Speaker 2: is very dangerous for markets when you have the feeling
Speaker 2: that these two economic actors at different ends of town,
Speaker 2: one in the city, one in Whitehall operating on different
Speaker 2: principles and with a different set of philosophies. This is
Speaker 2: really very bad news for markets.
Speaker 1: Is there a middle ground for Whitehall and the city
Speaker 1: in this context
Speaker 2: the unfunded tax cuts which Liz truss and her team
Speaker 2: quasi quoting the chancellor
Speaker 2: unveiled on the 23rd of september some of this will
Speaker 2: have to be unwound I believe already we've had a U.
Speaker 2: Turn on the top rate of tax. She wanted the
Speaker 2: top rate of tax to be scrapped. She said it
Speaker 2: was quite Teng's idea. So in a way she's throwing
Speaker 2: him under a bus that has been unwound that only
Speaker 2: would save a relatively small amount of money to three
Speaker 2: billion sterling. That's not a great deal in this context.
Speaker 2: I think they'll have
Speaker 2: to be other measures which will basically reverse some of
Speaker 2: the moves in the mini budget. The point is the
Speaker 2: catastrophic fiscal position of the U. K. Has not fully
Speaker 2: been revealed because the Chancellor and the Prime Minister didn't
Speaker 2: want the Independent office for budgetary responsibility to come out
Speaker 2: with its forecast at the right time. Which were operating
Speaker 2: a bit in the dark.
Speaker 2: But we do think that these unfunded tax cuts are
Speaker 2: going to be extremely difficult to finance and can only
Speaker 2: be financed at higher gilt prices. Hence the big sell
Speaker 2: off in the government bond market that we had at
Speaker 2: the end of september which has only been partly reversed.
Speaker 2: So if you're looking for changes tomorrow as you're saying
Speaker 2: then either they have to resend some of the tax
Speaker 2: cuts and raise more money by tax or they have
Speaker 2: to do a great deal more public borrowing that much
Speaker 2: you
Speaker 2: which is bad for the economy or they have to
Speaker 2: bring in some very unpopular and very socially divisive cuts
Speaker 2: in public spending. Those are the only three things they
Speaker 2: can do. And the cuts in public spending. Not only
Speaker 2: would they be unpopular, they would probably also be
Speaker 2: bad for the economy as well. So either way in
Speaker 2: all these three areas they're looking at a pretty difficult position.
Speaker 2: I think they'll have to do a mixture of all
Speaker 2: these things will be higher interest rates. There will be
Speaker 2: some cuts in public spending but not as regressive and
Speaker 2: especially divisive as some of the rather bad indications have
Speaker 2: have been telling us and they will have to be
Speaker 2: some rises in taxes which goes against the government's philosophy.
Speaker 2: So in all these three scenarios, we're looking at political
Speaker 2: and economic problems ahead for Britain.
Speaker 1: Indeed, David to play devil's advocate unfunded tax cuts. This
Speaker 1: is not the first time in history we have seen
Speaker 1: the americans have done that many times. Reaganomics and Arthur
Speaker 1: laughers invention of the laffer curve have been around for,
Speaker 1: you know, four or five decades and sometimes it seems
Speaker 1: like countries get away with it. And other times even
Speaker 1: with the best of independent forecasts, the market doesn't, you know,
Speaker 1: respect their decision to take some heroic fiscal moves. Um
Speaker 1: what went wrong for this particular juncture? I mean you
Speaker 1: have alluded to the lack of transparency being one that
Speaker 1: the forecasts were not available. People have been acting in
Speaker 1: the dark, but then there's also the cyclical weakness. I mean,
Speaker 1: has this been one case of bad timing and bad
Speaker 1: communication as opposed to the substance being fundamentally bad.
Speaker 2: Some of the substance you could defend because you could
Speaker 2: say that Britain's got a relatively strong national balance sheet.
Speaker 2: Everything is relative of course, but public debt as a
Speaker 2: portion of GDP something that 90% of GDP that's much
Speaker 2: higher than anybody would have thought comfortable
Speaker 2: 30 years ago, but it's still lower than Italy lower
Speaker 2: than France lower than japan. Clearly it's a little bit
Speaker 2: lower than the United States sterling though is not an
Speaker 2: international currency in the way the dollar is. And I
Speaker 2: think that's the salient difference. The americans can as we
Speaker 2: know
Speaker 2: funds their deficits through the famous exorbitant privilege that is
Speaker 2: accorded to the world's number one reserve currency Britain doesn't
Speaker 2: have that privilege. So it's a strange paradox that we
Speaker 2: have mr quan Teng. He seems to believe that sterling
Speaker 2: is still the world's number one reserve currency and people
Speaker 2: will therefore fund the deficit without tears.
Speaker 2: And that clearly isn't going to happen. So I think
Speaker 2: it was colossal arrogance actually on the part of trials
Speaker 2: and squatting and some of their advisors or some of
Speaker 2: the advisors did as I say, counsel very strongly against
Speaker 2: this plus grade poor timing plus an unwillingness to even
Speaker 2: talk to some market participants beforehand to gauge the reaction.
Speaker 2: So it is hubris and ignorance. I'm afraid to say
Speaker 2: pretty bad combination.
Speaker 1: David to your point that the pound is not an
Speaker 1: international reserve currency, but the city of London still has
Speaker 1: a sizable footprint in global international finance. Uh, and I
Speaker 1: worry that what has transpired over the last few
Speaker 1: weeks, which has been tumultuous for the UK markets but
Speaker 1: could be a sign of things to come at a
Speaker 1: time when global rates are going up. So could you
Speaker 1: walk us through your sense of the international ramifications is
Speaker 1: the sterling a canary in the coal mine, so to speak.
Speaker 1: For greater shocks, about to hit global markets.
Speaker 2: Well, I don't know whether it really is telling us
Speaker 2: about anything about the future. It certainly tells us that
Speaker 2: the past that we've seen is actually a valid yardstick.
Speaker 2: We've seen this in emerging markets, haven't we?
Speaker 2: In Brazil in Turkey, in Mexico, the action crisis of 1997,
Speaker 2: So it's actually confirming the past, it's also confirming some
Speaker 2: of the past British episodes. So we we saw the
Speaker 2: 1976 crisis when Britain had to go to the IMF
Speaker 2: we had the 1967 devaluation of sterling, which was the
Speaker 2: only the duomo of years and years of problems of
Speaker 2: battling against the current account
Speaker 2: deficit in the time of Bretton Woods. So it's confirming
Speaker 2: all that past history tells us that finance can be
Speaker 2: very unstable if you get your sums wrong and if
Speaker 2: you lose confidence, the the worry of course is that,
Speaker 2: as you say, Britain is from a market point of view,
Speaker 2: Britain is an important trading place. It's still without a doubt,
Speaker 2: the number one
Speaker 2: financial trading place in europe, despite Britain having left the
Speaker 2: european union now a couple of years ago, after the
Speaker 2: referendum in 2016. And Britain has taken over from Italy
Speaker 2: now as being the one big source of instability on
Speaker 2: the european markets and it's a bit rich really for
Speaker 2: a conservative Prime Minister, Liz truss who now comes in
Speaker 2: pledging some kind of stability
Speaker 2: and go for growth strategy that she has become singlehandedly
Speaker 2: the number one source of risk and instability on global
Speaker 2: financial markets. This is not a good position for a
Speaker 2: Conservative Prime Minister to be in. So I think it's
Speaker 2: more telling us the cautionary lessons of the past are
Speaker 2: justified rather than a
Speaker 2: pointer to all kinds of unrest in the future. Central
Speaker 2: bankers have been saying to me partly in jocularity, partly
Speaker 2: in sorrow that what Liz truss and quasi squatting has
Speaker 2: served up is actually very solitary for the new italian government,
Speaker 2: which we think will be led by joe joe Georgia
Speaker 2: maloney, the far right leader because it shows her what
Speaker 2: not to do. And I'm absolutely sure that Georgia meloni
Speaker 2: and her advisers are looking at this trust and saying, look,
Speaker 2: this is absolutely the wrong thing to do whatever we do.
Speaker 2: We have to maintain the trust on financial markets, We
Speaker 2: have to do what we can to show we're going
Speaker 2: to be good corporate citizens. They may actually have different
Speaker 2: views altogether, but outwardly they will be showing a good
Speaker 2: deal
Speaker 2: of conservatism and a good deal of orthodoxy, not least
Speaker 2: to curry favor with the creditor countries of europe who
Speaker 2: are supplying funds for italy and I'm afraid to say
Speaker 2: that mrs trust, forgot that she is a person who
Speaker 2: relies on the markets to fund the current accounts ever
Speaker 2: said Mark Carney, the previous Central black Governor coined the
Speaker 2: phrase because I don't really agree with. But he said
Speaker 2: Britain relies
Speaker 2: quotes the kindness of stroke quotes to fund its current
Speaker 2: account deficit. I don't think it's kindness is because people
Speaker 2: think that they can make a yield in Britain. But
Speaker 2: she's she's gone about it totally in the wrong direction
Speaker 2: and she hasn't realized she's got a deficit to finance.
Speaker 2: You've got to be nice to the creditors, you shouldn't
Speaker 2: be arrogant. And that's the lesson that she's failed to comprehend.
Speaker 2: I hope she does understand this actually. I do hope
Speaker 2: that the last few weeks have been solitary.
Speaker 1: So David, you have actually partially answered my next question
Speaker 1: because I was gonna ask you, is there a silver lining?
Speaker 1: And I think from a backhanded way you're basically saying
Speaker 1: that it is a cautionary tale and that's the silver lining.
Speaker 1: We will now have this lesson for the rest of
Speaker 1: the world what not to do anything else in terms
Speaker 1: of UK's public finance and the need for fiscal monetary
Speaker 1: policy coordination. Do you think that the lesson from the
Speaker 1: past few weeks would galvanize you know, better collaboration.
Speaker 2: I think it will Liz truss is not totally unintelligent
Speaker 2: and she's shown remarkable flexibility over the years. Don't forget
Speaker 2: she voted to stay in the European Union in the
Speaker 2: referendum in 2016. She's changed her tune a bit since then.
Speaker 2: She used to be a member of the Liberal Democrats,
Speaker 2: which she
Speaker 2: now ab jurors, she doesn't like the liberal democrats these days.
Speaker 2: So she's well known for her flexibility. She reminds me
Speaker 2: a bit of Groucho Marx, he said, I'm a man
Speaker 2: of many principles and if you don't like the ones
Speaker 2: I've got now, I have got other ones. So it
Speaker 2: could be that there will be a U turn in
Speaker 2: her philosophy. I also think it's good that the Bank
Speaker 2: of England again, as she was a time
Speaker 2: in a slightly backhanded way, has gained a bit of
Speaker 2: solidity and credibility through this. Andrew bailey, the governor, he's
Speaker 2: been in office now since the Covid crisis started, there's
Speaker 2: not been a very happy time for him over the
Speaker 2: last 2.5 years and there'll be people gunning for him.
Speaker 2: He's not been without blame. I have to say there
Speaker 2: have been some mistakes by the Bank of England, but
Speaker 2: he's sitting now in a more comfortable position
Speaker 2: because she's undermined everything else. We have a new monarch.
Speaker 2: We have a new prime minister, we have a new
Speaker 2: permanent secretary of the treasury when they get around to
Speaker 2: appointing that person. We have a new Chancellor of the Exchequer.
Speaker 2: So I don't think they're going to change or try
Speaker 2: to force out the Governor of the Bank of England
Speaker 2: at the same time. He's got another five years to
Speaker 2: go in his mandate and I think he'll be around.
Speaker 2: So if you want a silver lining, you might have
Speaker 2: a bit more institutional stability, particularly the Bank of England.
Speaker 2: And they may be in a better position perhaps to
Speaker 2: influence policy, but I still think it's going to be very,
Speaker 2: very rocky road, I'm afraid.
Speaker 1: Um David, one more question on the sterling crisis before
Speaker 1: we talk a little bit about europe and for this,
Speaker 1: I want to bring one uh you know, quotation from
Speaker 1: your book uh in your book you write and you're
Speaker 1: drawing a parallel between the 97 asian currency crisis in
Speaker 1: the september 92 crash at the pound. And you write,
Speaker 1: the root cause was misaligned exchange rates confronting countries with
Speaker 1: the task of amending monetary conditions for international reasons in
Speaker 1: a way that contradicted
Speaker 1: domestic economic and political requirements. Does that parallel work for
Speaker 1: the U. K. Today?
Speaker 2: I think it's less for sterling, sterling was overvalued, without
Speaker 2: a doubt against the euro and it's gone down a
Speaker 2: bit against the euro. Although nothing like as much as
Speaker 2: against the dollar, I don't think that we've had a
Speaker 2: fundamental misalignment of sterling. I think the problem is that
Speaker 2: we now have through the strong dollar a lot of
Speaker 2: dollar problems through higher interest rates now being transmitted to
Speaker 2: the emerging market economies.
Speaker 2: And I do think that those emerging market economies who
Speaker 2: have now had to suffer quite a large depreciation, they'll
Speaker 2: be importing inflation and they also have to pay much
Speaker 2: higher interest rates on their dollar debt without a doubt,
Speaker 2: that's going to cause huge dislocation for the emerging markets
Speaker 2: at a time
Speaker 2: when energy prices have been high, although they do seem
Speaker 2: to be coming down a bit now. So I think
Speaker 2: that has been the main issue shades of 1997 probably
Speaker 2: not because we don't have fixed exchange rates in the
Speaker 2: way that we did day factor or day jury in
Speaker 2: 1997 1998. But there has been a very strong devaluation
Speaker 2: of some of the emerging market currencies and that will
Speaker 2: not bring
Speaker 2: holy good news. I also think over time that the
Speaker 2: rise in the dollar will impede american competitiveness and will
Speaker 2: lead to an overvalued dollar. We've not got there yet.
Speaker 2: I think it might be partly because american manufacturing has
Speaker 2: got a lot stronger than we thought. Maybe that's because
Speaker 2: of technology as well as the Silicon Valley prowess has
Speaker 2: been transferred to the old economy part of America. That's
Speaker 2: why I, there's one
Speaker 2: I think relatively good piece of news which is that
Speaker 2: the american economy is more resilient than many people felt
Speaker 2: they are piling on the interest rate pressure somewhat late
Speaker 2: but better late than never at the Fed America is
Speaker 2: standing up to that. So America is without a doubt
Speaker 2: showing good signs of being the world's leading economy. The
Speaker 2: problem is the rest of the world can't quite keep up.
Speaker 1: Did I want to stick with the sterling one more
Speaker 1: moment please. Um, so we don't have the peril of
Speaker 1: a fixed exchange rate that was clearly exposed overvalued and
Speaker 1: that needed correction 92. We didn't have that over the
Speaker 1: last 6 to 9 months, but the pound nonetheless depreciated
Speaker 1: by 2025%. So if you are
Speaker 1: our primary belief is that the pound was not misaligned
Speaker 1: and therefore it is a different case now than it
Speaker 1: was then wouldn't that then by extension, make the pound
Speaker 1: substantially undervalued. Now, having experienced this depreciation,
Speaker 2: I don't think you can say it's undervalued given the
Speaker 2: size of the problems that we have and given the
Speaker 2: fact we don't know how the funding is going to
Speaker 2: come in and we don't know much at all about
Speaker 2: the future because there will be some changes in policies
Speaker 2: as I've indicated. The one thing we do know is
Speaker 2: that interest rates will be higher in Britain than the
Speaker 2: government would like. That's going to probably increase the scale
Speaker 2: of the recession even though the government is talking about
Speaker 2: relatively shallow recession.
Speaker 2: And so the high interest rates I think will maintain
Speaker 2: sterling as a relatively attractive currency. It will not be
Speaker 2: good news for people who actually live in Britain and
Speaker 2: have to put up with these higher costs on mortgages
Speaker 2: and so on. But that's why I'm not fearing an
Speaker 2: actual sterling crisis. I'm fearing more a recession that will
Speaker 2: certainly still further undermine the government and will probably lead
Speaker 2: to a labor Party victory
Speaker 2: at the general election. It may happen before two years,
Speaker 2: but the next general election is due in around two
Speaker 2: or 2.5 years, there may be an election beforehand. So
Speaker 2: this political instability I think will not be good news.
Speaker 2: But I don't fear a sterling crisis. I think the
Speaker 2: institutions as we have them will be ready to withstand that.
Speaker 2: I do fear a lot of political vicissitudes. It could
Speaker 2: be though
Speaker 2: That a new labor government might actually end up being
Speaker 2: a more stable situation than the outgoing Tory government. We
Speaker 2: saw this of course in 1997 when Gordon Brown and
Speaker 2: Tony Blair came in and that actually led to quite
Speaker 2: a good constellation for several years. So you can't give
Speaker 2: up totally on Britain yet. But there will be big
Speaker 2: oscillations politically, I believe
Speaker 1: by all means David. Okay, we'll switch to europe now.
Speaker 1: Um they are also, you know, confronting all sorts of
Speaker 1: challenges and somewhat reluctantly but inevitably PCB is raising grades
Speaker 1: and we have monetary policy normalization taking place exactly at
Speaker 1: a time when the content is likely heading towards a
Speaker 1: recession
Speaker 1: and talk about sovereign problem. They also have a mountain
Speaker 1: of sovereign debt to manage. So two sets of questions first,
Speaker 1: how are the key institutions of european union standing up
Speaker 1: to the threat of war stagflation and risks of yet
Speaker 1: another debt crisis.
Speaker 2: The E. C. B, as you say, belatedly is raising
Speaker 2: rates and at the same time they brought in this
Speaker 2: instrument to try to combat fragmentation because you don't need
Speaker 2: a Nobel prize in economics to work out that when
Speaker 2: interest rates go up quite sharply as they are doing
Speaker 2: both short term and longer term. This makes life more
Speaker 2: difficult for countries like Italy, which you've got a public
Speaker 2: debt to GDP ratio of 150%
Speaker 2: that that country is going to suffer more. So they
Speaker 2: brought in this famous transmission protection instrument which is supposed
Speaker 2: to mitigate this. This is actually rather akin to the
Speaker 2: Bank of England's special facility which they brought in on
Speaker 2: the 28th of september this, this guilt purchase instrument. The
Speaker 2: difference is though, that the T. P. I hasn't been
Speaker 2: spelled out in any detail and it hasn't been used
Speaker 2: with the Bank of England has use
Speaker 2: It's a special instrument that it unveiled on 28 September
Speaker 2: although it hasn't used much of it quite cleverly, I
Speaker 2: think it's not used that much. So there's some weapons
Speaker 2: in the armaments in the arsenal of the PCB that
Speaker 2: is not used yet. I don't think the T. P.
Speaker 2: I will be used because it's quite difficult for Italy actually.
Speaker 2: So I I believe therefore that the spreads will continue
Speaker 2: to rise in
Speaker 2: Between say Italy and the German bonds at the moment,
Speaker 2: they're about 2.4% points. I think they'll go a bit
Speaker 2: higher there creep up slowly without a real sense of crisis.
Speaker 2: I believe they will be relatively shallow recession in Germany,
Speaker 2: don't forget Germany's actually throwing the kitchen sink at this.
Speaker 2: It's using its balance sheet as well. Not in a
Speaker 2: very communitarian way. There's been a lot of criticism of
Speaker 2: the 200 billion
Speaker 2: euro package that Germany brought in to safeguard the consumers
Speaker 2: over this energy crisis. And yet they have stopped so
Speaker 2: far
Speaker 2: a price cap for energy for europe as a whole
Speaker 2: is very much a Germany first policy, I'm afraid to say.
Speaker 2: And you've seen this on many occasions in the past,
Speaker 2: Germany does have a pretty nationalistic or certainly a national
Speaker 2: way of doing things. And this is not good news
Speaker 2: for the rest of europe. So the Bundesbank would like
Speaker 2: to have still higher interest rates and they'd like to
Speaker 2: start quantitative tightening. That will not happen
Speaker 2: because they are worried about italy we'll probably still have
Speaker 2: yields and interest rates in real terms at negative levels
Speaker 2: next year. I believe in europe, the CCB will not
Speaker 2: slam on the brakes big time. They will not be
Speaker 2: as aggressive as the Fed that will have to outcomes one,
Speaker 2: it might mitigate the scale of the recession because they
Speaker 2: will not be so uh
Speaker 2: aggressive in monetary tightening as the americans. And I also
Speaker 2: think we'll have a relatively weak euro, which could also
Speaker 2: be quite helpful for the economy. So I don't foresee
Speaker 2: a huge crisis in europe, I think they'll do just
Speaker 2: about enough to muddle through. But all the old question
Speaker 2: marks that we've had about monetary union ever since the beginning.
Speaker 2: You know, the lack of real political union at a
Speaker 2: time when you've fused together the monies
Speaker 2: and I've got just one single currency, all these old
Speaker 2: question marks will still be with us, I'm afraid it
Speaker 2: will be a case of further muddling through and a
Speaker 2: sense that monetary union is still incomplete. And and the
Speaker 2: sense that without a lot of permanent crisis fighting,
Speaker 2: the monetary union could break up. And that's again at
Speaker 2: a time time of war in Ukraine, not a comfortable position,
Speaker 2: but the very fact that there is a war in
Speaker 2: Ukraine means I think that the politicians and the central
Speaker 2: bank will go the extra mile to put the sticking
Speaker 2: plaster over this unfinished edifice of monetary union. So I
Speaker 2: don't actually foresee it will break up any time soon,
Speaker 2: but it does remain a long term question mark.
Speaker 1: But in the near term, you think that the fragmentation
Speaker 1: risk coming from a likely debt crisis is mitigated by
Speaker 1: the unity that is being forced upon europe because of
Speaker 1: the threat of war.
Speaker 2: That's right. They cannot afford to lose italy at this time.
Speaker 2: And of course, Giorgia meloni knows that he knows that
Speaker 2: she's got some strong bargaining cards. The bank of italian,
Speaker 2: very adept at playing
Speaker 2: This game. The Germans have already become substantial creditors of
Speaker 2: the euro area through the target to mechanism that's now
Speaker 2: one of well over €1 trillion Bundesbank has advanced to
Speaker 2: the E. C. B. basically to keep the balance of
Speaker 2: payments going throughout the euro area. So through these mechanisms
Speaker 2: there will still be a lot of sticking plaster in place.
Speaker 2: I think the Germans will have to show a more
Speaker 2: community minded attitude actually over energy and they will have
Speaker 2: to also probably advance more guarantees and more loans of
Speaker 2: a europe wide dimension following on from the next generation
Speaker 2: EU fund that was agreed two years ago. I think
Speaker 2: there has to be more such super national borrowing mechanisms
Speaker 2: to help europe through the crisis. And that will not
Speaker 2: please the purists who say that
Speaker 2: the EU needs to have a proper political underpinning and
Speaker 2: you can't keep going on through these ad hoc measures
Speaker 2: but that would that would involve treaty change to change
Speaker 2: the whole bedrock of the european union and actually to
Speaker 2: make it a proper union making a political union at
Speaker 2: the moment. There's no likelihood of that happening in any
Speaker 2: country that no country would wish to go through the
Speaker 2: whole
Speaker 2: upheaval of a treaty change which will lead to referendums.
Speaker 2: Many countries will have to lead to constitutional changes in
Speaker 2: Germany as well as other places. So we'll continue with
Speaker 2: the sticking plaster but it'll be pretty messy. I would
Speaker 2: say
Speaker 1: the largest that the government of Germany is sort of,
Speaker 1: you know, doling out to its population to deal with
Speaker 1: the high inflation and likely sort of crunch in energy supply.
Speaker 1: Um does that mitigate substantially the risk of recession out
Speaker 1: of Germany or it's still not,
Speaker 2: it's certainly there is a strong sense that the recession
Speaker 2: in Germany
Speaker 2: Will be relatively shallow. I'm probably not in line with
Speaker 2: consensus here, some people are broadcasting a -2 or -3%
Speaker 2: next year. My relatively sanguine forecast is based on the
Speaker 2: fact that I think there'll be a relatively mild winter.
Speaker 2: Obviously I'm not a meteorologist, but I'm just thinking that
Speaker 2: global warming is starting to have an effect and therefore
Speaker 2: the increase in energy prices will also encourage Germans to
Speaker 2: switch off some of their heating and not use as
Speaker 2: much energy as well as the relatively mild weather. And
Speaker 2: I'm also foreseeing some national measures to help.
Speaker 2: They're certainly not going to go back to this idea
Speaker 2: of this fiscal break, which they've got in the constitution,
Speaker 2: they will override that they will certainly have deficits next
Speaker 2: year in Germany. And also they've discovered as all the
Speaker 2: other countries have discovered the wonderful way of doing mechanisms
Speaker 2: outside the budget.
Speaker 2: This special fund for the defense industry, the 100 billion
Speaker 2: shots unveiled just a couple of days after the Russian
Speaker 2: invasion plus this new 200 billion, a lot of that
Speaker 2: would be financed off budget? The Germans of course are
Speaker 2: digging a hole for themselves because they've always been the
Speaker 2: ones who are telling people they should stick to the rules.
Speaker 2: But sometimes the Germans make rules which are really for
Speaker 2: others rather than for themselves. So again, this may not
Speaker 2: be perhaps the right example to give to
Speaker 2: mrs maloney when she comes to power. The Italians are
Speaker 2: very good also inventing all sorts of inventions and all
Speaker 2: kinds of subterfuges outside national budgets. We're going to see
Speaker 2: a lot of that. So tomorrow you and your colleagues
Speaker 2: who look at all these things, you have a lot
Speaker 2: of different budgets to study not just the national budget,
Speaker 2: but the off budget mechanisms in lots of european countries.
Speaker 2: That way, I think Germany will actually escape a really
Speaker 2: severe recession. And I think that's relatively good news. I
Speaker 2: have to say
Speaker 1: before the sake of a thought experiment, let's assume it's
Speaker 1: going to be a very harsh winter. You know, even
Speaker 1: in the context of that, have there been enough safeguards
Speaker 1: put in place in terms of energy stock in terms
Speaker 1: of giving financial war. We're told to the likely affected
Speaker 1: that even a harsh winter can be dealt with.
Speaker 2: If we did have a harsh winter, then they would
Speaker 2: have to be rationing. There would have to be gas
Speaker 2: supplies being cut off state between four o'clock in the
Speaker 2: afternoon and 12 o'clock at night in big cities. Even worse.
Speaker 2: A lot of large chemical companies, for example, B A.
Speaker 2: S F on the Ryan
Speaker 2: the world's biggest chemical company would have to just close
Speaker 2: down for weeks on end. You can't just close this
Speaker 2: down for a few hours, you have to close it
Speaker 2: down for weeks, they'd have to furlough workers. I'm not
Speaker 2: saying that they would be civil unrest, but there clearly
Speaker 2: would be demonstrations in the streets about this in
Speaker 2: in Germany, the german, the german government would throw money
Speaker 2: at it as it always does, but this could certainly
Speaker 2: lead to a breakdown of the coalition. For example, in
Speaker 2: that worst case scenario, any thought of tightening would have
Speaker 2: to be put on ice. The balance sheet would continue
Speaker 2: at a very, very high level
Speaker 2: and Putin would clearly feel that he's won a major victory.
Speaker 2: If large girl hardship was to take place in Germany
Speaker 2: and Bsf were to close down his plant, say for
Speaker 2: three months, which it might have to do in,
Speaker 2: in the worst case scenario. And there is a parallel action.
Speaker 2: It was 1992 here because several people in 1992 said,
Speaker 2: europe is playing paying the price for german unification. The
Speaker 2: Germans had to stick up the interest rates in 1991
Speaker 2: 1992 which did lead to the pounds ejection from the
Speaker 2: E R. M. And of course Italy left on the
Speaker 2: same day as the pound on the 16th of september
Speaker 2: 1992 and you could mount a case now if you
Speaker 2: wanted to,
Speaker 2: If you wanted to be relatively harsh on Germany, you
Speaker 2: could say that Europe is paying the price now for
Speaker 2: German misjudgments because Germany did undoubtedly put too many of
Speaker 2: its energy eggs into the Russian basket over the last
Speaker 2: 20 years, 55% of all Germany's gas imports of all
Speaker 2: its gas use came from Russia on the eve of
Speaker 2: the invasion.
Speaker 2: And there's been a tremendous effort by the Germans to
Speaker 2: make up for that by taking gas from other countries,
Speaker 2: driving up world prices actually. And some of this is
Speaker 2: quite unfair. It certainly means that there's less gas to
Speaker 2: go around for everybody else, particularly the emerging markets. So
Speaker 2: you could say there's a parallel between German misjudgments over
Speaker 2: unification and having to finance a lot of this through
Speaker 2: higher interest rates in 1992
Speaker 2: and misjudgments on the energy side here. So again, we
Speaker 2: come back to the parallels. It's not a perfect way
Speaker 2: of saying the two episodes are similar, but there are
Speaker 2: certainly some parallels and some convergences. I would just like
Speaker 2: us to think we can learn from some of these parallels.
Speaker 1: So, David, we've talked about the context of Germany and
Speaker 1: Italy in this situation. What about the rest of europe
Speaker 1: started with France and perhaps a few other peripheral european countries,
Speaker 1: both the economics and energy security issues. How do you
Speaker 1: see them playing out?
Speaker 2: It's been very interesting to look at France in the
Speaker 2: last few months because of course France has put a
Speaker 2: lot of effort over the last 50 or 60 years
Speaker 2: into nuclear energy. The civil use of nuclear energy very
Speaker 2: tied up. Of course with the French nuclear deterrent in
Speaker 2: the military use has been a light motive of all
Speaker 2: the governments since the second world war. And that has
Speaker 2: really come to a pretty sticky point at the moment.
Speaker 2: Half of the French nuclear power stations are not
Speaker 2: operable at the moment because of some problems over corrosion,
Speaker 2: engineering problems, lack of water during the very hot and
Speaker 2: dry summer. So there's big energy problems in in France
Speaker 2: as well. There would be a good opportunity for more
Speaker 2: gas sharing out also using some pipelines from Spain Spain
Speaker 2: has got a lot of liquefied natural gas, but that
Speaker 2: seems to be blocked by various disagreements and squabbles within
Speaker 2: the european union.
Speaker 2: So, I would like to think that there could be
Speaker 2: much more of an energy union between say Italy Spain France,
Speaker 2: Germany and even the UK using the interconnector that we
Speaker 2: have underneath the english channel for nuclear exports from France
Speaker 2: to Germany sorry, from France to the UK at the moment,
Speaker 2: France isn't exporting electricity because of these problems I've mentioned
Speaker 2: in the in the nuclear side.
Speaker 2: So I'm not wholly without any kind of confidence in
Speaker 2: the future here. There could be a new angle here
Speaker 2: to push forward an energy union in Europe and I
Speaker 2: would hope that over the next 1-2 years. We will
Speaker 2: see this will see me
Speaker 2: More efforts to share energy. Will see more efforts to
Speaker 2: save energy. We will also see more efforts to go
Speaker 2: further on the renewable energy side. Despite all the problems
Speaker 2: we know about that, it is relatively cheap. So looking
Speaker 2: at the longer term, I'm relatively hopeful it is getting
Speaker 2: through not just this winter, but the winter 2023 2020
Speaker 2: for that's going to be problematic.
Speaker 2: I think Putin has without doubt underestimated the resolve of
Speaker 2: the West to stand up to the aggression both militarily.
Speaker 2: He's probably been surprised by that. He's been surprised by
Speaker 2: the incompetence of his own army as well. But he's
Speaker 2: probably also been surprised by relatively large amount of economic
Speaker 2: solidarity despite the problems I've mentioned just now. I I
Speaker 2: very much hope that that will continue. And again, I
Speaker 2: I do think that the sorry state that Britain is
Speaker 2: in showing what happens if you go on a go
Speaker 2: it alone? Rather arrogant path. I would very much hope
Speaker 2: that that could have some positive impact on the rest
Speaker 2: of europe and maybe over a longer period of time
Speaker 2: will have some positive impact on Britain at all Britain
Speaker 2: as well. I'm not talking about Britain rejoining the european union,
Speaker 2: but I'm very much hoping that there'll be more of
Speaker 2: an effort by the U. K. To go into lockstep
Speaker 2: with France, Germany Italy and spain
Speaker 2: in coming years,
Speaker 1: right, We can keep our fingers crossed for that. David,
Speaker 1: let's zoom away from europe UK and just go above
Speaker 1: the earth and take a look at the whole world.
Speaker 1: How is the outlook looking for next year? Is it
Speaker 1: pretty dark?
Speaker 2: The american economy is one source of greater confidence. I
Speaker 2: do believe that America despite all its many political problems,
Speaker 2: is proving itself to be the number one. Therefore, I've
Speaker 2: got some hope that the locomotive function of America despite
Speaker 2: the problems it's causing for emerging markets will continue to
Speaker 2: being a relatively stabilizing factor.
Speaker 2: I would like to think that the european recession will
Speaker 2: not be as severe as many people think it will
Speaker 2: be more of a blip. I'm obviously not expecting and
Speaker 2: certainly not hoping for an escalation further escalation in Ukraine.
Speaker 2: So a lot of these hopes for next year are
Speaker 2: predicated on
Speaker 2: a relatively orderly path of the war if you can
Speaker 2: use those terms. Because I know a lot of the
Speaker 2: war is absolutely horrible. So we shouldn't start thinking of
Speaker 2: this like a
Speaker 2: like an economic operation. I'm thinking the war will will
Speaker 2: carry on for at least another year. But I'm very
Speaker 2: much hoping it would lead to a continued escalation which
Speaker 2: will mean that nuclear weapons get called in in some way,
Speaker 2: which clearly would put an end to all our hopes
Speaker 2: in in very many ways. So I'm relatively hopeful there
Speaker 2: will be more international cooperation a lot depends on the
Speaker 2: midterm elections of course in the United States and whether
Speaker 2: or not we
Speaker 2: see further polarization and a return to trumpism. So I'm
Speaker 2: not catastrophically gloomy about the world economy, but there are
Speaker 2: a lot of caveats in what I've just said,
Speaker 1: Assuming that the war does not exacerbate to the direction
Speaker 1: of creating renewed bouts of panic about food and energy supply,
Speaker 1: assuming that doesn't happen. Would inflation globally come down substantially
Speaker 1: in 2023?
Speaker 2: I think in the United States there's greater feeling that
Speaker 2: it will simply because we do have a lot of
Speaker 2: monetary aggression in the United States belatedly. So they are
Speaker 2: thinking of putting up the Fed funds rate to above 45%
Speaker 2: I think if we have that and assuming the american
Speaker 2: economy can stand up to that
Speaker 2: And also assuming that the energy supply doesn't become too
Speaker 2: tight for the rest of the world. And assuming the,
Speaker 2: the American ideas of some kind of oil price cap
Speaker 2: to work, then I could see that we could have
Speaker 2: a positive inflation shock in the United States towards the
Speaker 2: end of next year. I think that European inflation will
Speaker 2: be 6% next year. So we will not see
Speaker 2: Any very rapid fall in the inflation rate in Europe,
Speaker 2: but it will not continue at the figures difficult in
Speaker 2: some parts of the European Union, in the Baltic states,
Speaker 2: we do have not just double figures, but we have
Speaker 2: above 20%.
Speaker 2: So based on a feeling that there will be a
Speaker 2: greater degree of orderliness in the energy markets and some
Speaker 2: of the commodity prices have anyway been starting to fall
Speaker 2: for several months and then we will see some fall
Speaker 2: in inflation but there's no way that the C. B.
Speaker 2: Can get back to its target of 2% by 2024
Speaker 2: I think we'll be talking about 6% next year. And
Speaker 2: maybe if we're lucky 3 to 4% in 2024
Speaker 2: For Europe and a bigger decline in inflation in the
Speaker 2: United States. And the continued high inflation rates in Europe
Speaker 2: could have some mitigating effects on Italian debt because there
Speaker 2: is one classic way of inflating away the debt, if
Speaker 2: Italy can manage to grow at 2-3% over two years
Speaker 2: and therefore they continue to have an inflation rate of
Speaker 2: say 6%
Speaker 2: then they will have a G. D. P a nominal
Speaker 2: GDP rise let's say something like 15% over the next
Speaker 2: two years. That's quite a good way of inflating away
Speaker 2: some of the excessive debts that they have. This is
Speaker 2: not something that european central bankers like to talk about
Speaker 2: in public because of course it goes against the grain
Speaker 2: to say you're using inflation to lower the debt problem.
Speaker 2: But behind the scenes european central bankers are saying sort
Speaker 2: of that that could be a positive side effect of
Speaker 2: high inflation. It might make the debt position of some
Speaker 2: of the over indebted states principally. Italy a bit less parlous.
Speaker 1: Absolutely, David. I mean, this is one issue where it
Speaker 1: is very close to my heart that I believe that
Speaker 1: from a policy makers perspective, given the mountain of debt
Speaker 1: we have in the world that the risk of substantially
Speaker 1: lower nominal expansion is far greater than you know, substantially
Speaker 1: higher nominal expansion,
Speaker 1: be it through stagflation or just through robust growth. I
Speaker 1: think the denominator fact is very important. It's very important
Speaker 1: to sort of keep the debt deflation risk away. And
Speaker 1: so I think if I, for me, you know, I
Speaker 1: would err on the side of inflation as opposed to
Speaker 1: the side of deflation. Um David, you end your book,
Speaker 1: six days in september which I highly recommend to the
Speaker 1: listeners of Kobe time. Uh and you have this
Speaker 1: rather meta observation at the end, the tangled and tragicomic
Speaker 1: tale of black Wednesday provides a warning of how great
Speaker 1: plans can go awry.
Speaker 1: So here we are in 2022, which great plans are
Speaker 1: at risk of going to rise today?
Speaker 2: Well, well, first of all, just to clarify what I
Speaker 2: meant by that, the problem about the british membership of
Speaker 2: the er M was that it did it for totally
Speaker 2: different reasons compared with those that were there under the continent.
Speaker 2: So Britain entered the er m simply to get inflation
Speaker 2: down and also to get interest rates down.
Speaker 2: That's why mrs thatcher rather grudgingly agreed with john major
Speaker 2: to do that on the continent. They saw it totally differently.
Speaker 2: They saw the er m as being, if you like
Speaker 2: the front window or the waiting room for monetary union.
Speaker 2: So you had these two countries or two sets of
Speaker 2: countries doing the same thing for totally different reasons and
Speaker 2: that's what caused it all to come unstuck
Speaker 2: in the end and that is a danger. I think
Speaker 2: that people, for all kinds of political and economic reasons
Speaker 2: carry out a certain policy but for reasons of principle
Speaker 2: or philosophy which are entirely divergent and that is the
Speaker 2: tangle that you get yourself into. Now I think if
Speaker 2: you take today's situation and say take global warming, there
Speaker 2: is a consent
Speaker 2: consensus that global warming is on the whole man made
Speaker 2: and there's a consensus that we should be doing all
Speaker 2: kinds of things to try to mitigate the rise in
Speaker 2: temperatures and that's why we have all these summits and
Speaker 2: so on. But people are actually doing all this for
Speaker 2: totally different reasons. And of course they're reversing this. Now,
Speaker 2: look at the amount of money going into coal mining
Speaker 2: these days. So that's how these great plans can go
Speaker 2: awry firstly, different countries doing
Speaker 2: what seems to be the same policy for a whole
Speaker 2: set of different political and economic reasons, some of which
Speaker 2: is very domestically driven and then plans getting upset by
Speaker 2: what Harold Macmillan, the former british prime Minister calls events events,
Speaker 2: dear boy events, events, getting in the way of grand plans,
Speaker 2: german unification got in the way of the plan to
Speaker 2: keep interest rates low, for example, in in
Speaker 2: europe, and in the same way you have a war
Speaker 2: in Ukraine getting in the way of global warming efforts
Speaker 2: to counter climate change because people have been going back
Speaker 2: along the coal route now very extensively. So that's the danger.
Speaker 2: I think that these plans do get derailed and I
Speaker 2: think the
Speaker 2: the fight against climate change is a good case in
Speaker 2: point that has been derailed by the efforts to get
Speaker 2: back into coal mining, not just in europe, but much
Speaker 2: greater extent in India and in china, that is going
Speaker 2: to be a real setback, I have to say, you
Speaker 2: could say over time, renewable energy will come
Speaker 2: and rescue us all. It's a relatively small part of
Speaker 2: the world, i. E, europe is making efforts on that,
Speaker 2: but look at India and china. So that's what I
Speaker 2: mean about grand plans going awry. And it's I think
Speaker 2: goes much deeper than the relatively small issue about Britain
Speaker 2: and the er m 30 years ago, there's a much
Speaker 2: greater global
Speaker 2: action over climate change which is now being seriously put
Speaker 2: at risk by the perturbations we saw in the world economy.
Speaker 2: So Britain and the er m that clearly is a
Speaker 2: sideshow is intellectually and politically and economically interesting, but it's
Speaker 2: a it's a footnote in history compared with the much
Speaker 2: more massive actions and the much more massive campaign
Speaker 2: to try to counter climate change and that is the
Speaker 2: big worry, I think that that that's going to be
Speaker 2: substantially undermined and diverted by the aftermath of the war
Speaker 2: in Ukraine. So I just hope we can find a
Speaker 2: way of getting back on track on that question without
Speaker 2: losing too much time which would be causing the world
Speaker 2: irreparable damage.
Speaker 1: Very critical piece of insight, David, I mean, thank you
Speaker 1: very much and I really appreciate because it is a
Speaker 1: cautionary tale for the various grand plans that we have,
Speaker 1: which we believe that you know, there is a global
Speaker 1: consensus to implement but events shocks they get in the
Speaker 1: way and I think that's where the importance of planning
Speaker 1: with shocks in mind. Come in. Uh David Marsh, this
Speaker 1: has been fantastic. Thank you very much for your time
Speaker 1: and insights.
Speaker 2: Thank you. Timer. All the best to you. Goodbye.
Speaker 1: Thank you and thanks to our listeners Kobe time was
Speaker 1: produced by ken Del Bridge from Spy Studios daisy Sharma
Speaker 1: and violently provided additional production assistance Kobe time is for
Speaker 1: information only and does not represent any trade recommendations. All
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Speaker 1: great day