What is at stake in the European elections? My weekly column

European elections are generally deemed to have little impact on national affairs and so are always seen as secondary, and a far cry from presidential elections.

Voter turnout is usually low, and this is the case across the board, not just in France. The chart below shows voter turnout rates in France and the European Union since the first European elections in 1979, and we can see that the two trends display the same profile: France is no different. Voters were relatively enthusiastic when they first went to the polls in 1979 with turnout of more than 60%, but the past three elections have seen similar figures of just above 40%.

In France, there is generally little similarity between presidential and European elections, as the winning parties in the French presidential elections are rarely the victors of the European elections. The French president’s party has won the European elections only twice since 1979: in 1979, the UDF party (Union for French Democracy) won when Valérie Giscard d’Estaing was in power, while in 2009, the UMP (Union for a Popular Movement) won when Nicolas Sarkozy was at the helm.

When François Mitterrand, Jacques Chirac and François Hollande were in power, their parties did not win the European elections. During Mitterrand’s presidency, the Socialist Party came in second each time, while during Chirac’s time as president, the UMP came in second in 2004 but at the 1999 elections, RPR (Rally for the Republic) dissident Charles Pasqua came in second. Later in 2014, the Socialist Party was third behind the National Front and the UMP. In other words, the results of the European elections do not necessarily mirror the domestic political landscape, and the results seen since 1979 have not had any effect on domestic politics.

But what are the specific features of the European elections this time around?

1 – The first point is that this is the first time that an EU member state will vote for MEPs while at the same time being in the process of leaving the bloc.

2 – The second aspect is that this election is taking place in an unusual economic and political context. Growth is weaker than in the past across almost all EU countries, while inequality is worsening, and populist tendencies are on the rise.

Growth is more sluggish, which means that there is less scope to redistribute income than before, with the economy generating a smaller surplus for distribution among citizens.

This trend is further heightened by changes on the labor market, with greater polarization and the ensuing hit for intermediate jobs for staff with few or unsuited qualifications. This situation is the result of innovation that has changed the production process on the one hand, as well as the swift development of unskilled work in the services sector on the other. These jobs have become very individualized and in a break from the past, they no longer create a feeling of belonging to a specific class.

3 – The issue of income does not provide sufficient explanation, and added to this problem of income and wage inequality we are also seeing inequality in access to public services, inequality in access to healthcare, education and training, as well as geographical inequalities i.e. real estate prices are lower the further you go from city centers, and this leads to greater isolation and much higher transportation costs. This is why an increase in purchasing power is probably one key condition for swiftly restoring social order, but still an insufficient answer.

We cannot rule out the possibility that this instability experienced primarily by the middle classes – where income is close to or below the median – leads to changes in behavior, and this may have fueled the rise of populism in western Europe.

The political risk of these elections is that we could see more untraditional votes than in the past, although not necessarily in France, where the National Front already attracted almost 25% of votes in 2014, but in Europe as a whole. So it is possible that populist and extreme parties may increase their ties to fight against both incumbents and the elites who have not managed to reduce inequality in the long term.

4 – There is something of a shortage of ideas on Europe. The EU fulfils its primary purpose that it was set up to achieve, by keeping peace in the region. Yet it lacks momentum and fails to offer any real answers to address a seemingly paralyzed context. In other words, Europe is no longer at the heart of change in today’s world. Europe is never mentioned in the conflict between China and the US, yet the battle of wills between these two countries will shape the world of tomorrow: Europe is absent from this equation and does not seem able to do anything about it.

Europe is vital in this world context as it fosters a degree of political stability and also affords some power to all its member countries. Each country individually would have no real presence and no power to influence the future course of events, so this ability to have an influence makes Europe a necessity. Each member state is very aware of this, yet they do not have the clout to change the course of the future.

5 – Bar any major surprise, the European elections will have little effect on the financial markets, but it will be important to analyze the political balance that emerges between pro-Europeans and euro-sceptics like Orban in Hungary. This could shape the future majority in the European Parliament and the ensuing shape of the European Commission. The result will reveal Europe’s ability to comply with and further develop the rules it has set.

All eyes will be on Italy, as the coalition currently in power could be further weakened by the European election results. The Five Star movement saw its influence wane recently and the government it forms with the League could quickly be undermined. The League is doing very well in opinion polls, and the Democratic Party (former Socialist party) is doing better than the Five Star Movement. The result in Italy will be the most closely monitored as it is probably the only one that will have a real impact on the domestic balance in the short term.

This post is available in pdf format My Weekly Column – 21 May

“Politicians” take their revenge – My weekly column

The world of politics and politicians wants to get its own back on the central banks. Central banks have been at the very heart of steering the economy since the start of the crisis at the very least, as they have been more present and reacted more swiftly than governments, bar a few exceptions such as coordinated fiscal stimulus moves in 2009.

Yet politicians are now wading in to tackle central banks’ domination at various levels. Firstly, Democrats are championing the MMT – Modern Monetary Theory – approach, suggesting that governments are responsible for managing the economy. Then we have the politicization of the central bank, with Donald Trump’s attempts to appoint members who are not renowned first and foremost as economic experts, or Erdogan taking control of the central bank in Turkey, while in India, Modi changes governor each time the current one no longer meets his requirements.

Politicians now want the pendulum to swing back in their direction as they seek to take back control after letting central banks play a key role in steering the economy. But it may not be that straightforward.

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A recap of central banks’ independence

Central banks have had a considerable grip on economic trends for the past several years. At the start of the 1980s, their role was to cut back inflation, after governments had let it spiral out of control. Paul Volcker went all out on this front, and this shift in the balance of power gained greater ground over time. Theoretical and empirical indications bore out this idea that an independent central bank was required to facilitate and optimize regulation of the economy.
When the euro area was set up, the central bank’s independence became the norm for member countries as well as several other countries.

Having two bodies to steer the economy and reform economic structures – the government and the central bank – was deemed wise. Work on coordination of economic policy has enhanced the way the two work together to make for more efficient running overall.

After the 2008 watershed, central banks’ crisis management moves increased their influence. Implementation of unconventional monetary policy in the US and the UK gave monetary authorities a major advantage, enabling governments to take on debt to address the aftershock of the financial crisis and spread out its effects over the longer term, while also covering this debt via vast purchase programs, or Quantitative Easing. Meanwhile, the development of forward guidance on expected future interest rate trends enabled central banks to steer investors’ expectations over the long term and avoid any potential unwanted rate trends.

In the euro area, the ECB became more independent when Mario Draghi took over at the helm: he made the monetary authority a true lender of last resort, gave the euro greater independence and shifted the central bank’s political balance that had been so troublesome for his predecessor to the detriment of real economic questions. Quantitative Easing and the forward guidance process also helped assert this greater independence.

* * *

Doubts over this independence

Politicians have now seen that reality is running away from them and central banks have too much clout in controlling the economy.
Donald Trump swiftly explained that excessively high interest rates hampered US growth, but Jay Powell, the Chair he had himself appointed, held up under this pressure. The President is now endeavoring to stymie the monetary policy committee by appointing members who do not have the rights skills and experience, such as Stephen Moore and more recently Herman Cain, before he retracted. The White House’s nominations have to be approved by Congress so the game is not over yet, but a potential second term for Trump in 2020 could upturn this balance due to the seats on the board coming up for nomination. This is a huge risk for the Fed’s independence over the years ahead.
Republicans in Congress very recently wanted to set a well-defined framework for the Fed’s actions along the lines of the Taylor rule. This would clearly limit the central bank’s scope to make its own interpretations of the economic situation, with the risk of triggering excessive interest rates movements that could disrupt the pace of the economy in the long term.

In the shorter term, the main doubt over central banks comes from the American Democratic party and its most left-wing potential presidential election candidates.
Bernie Saunders and Alexandria Ocasio-Cortez (AOC) in particular want to give politics precedence over economics again, with politics leading and economics merely managing. They base their approach on Modern Monetary Theory, which suggests that the size of the deficit is not very important if debt is financed in local currency: against this backdrop, the economy is steered and adjusted via changes in spending and tax and no longer by movements on interest rates primarily.

With this approach, growth and inflation would thus be better steered by the government than the central bank. A number of economists are unconvinced by this method, which is a theory in name only: it is also worrying as when governments have taken control over the economy in the past, it has been to the detriment of the central bank and often ended with phases of marked instability. This particularly calls to mind hyperinflation in Germany, although this may seem an excessive viewpoint with evenhanded elected leaders.

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Long-lasting shift

What matters here is not so much the theoretical approach, but rather the potential change it could trigger in the pecking order for the economy’s different managing authorities. If the pyramid of powers were to change, the central bank’s action would then depend on the government’s moves in a radical turnaround compared to the past 40 years. There are several points worth noting.

We will need to keep a close eye on the forthcoming replacement for Draghi and other members of the board at the ECB, as we keep this balance of power in mind, particularly as these changes will take place after the European elections.

However, the central banks have a major advantage: in the past, they have systematically stuck together during crisis periods to curb risks on liquidity. This ability to react and work together outside any political framework helped reduce both the length and the extent of crises. Yet we cannot spontaneously expect any similar behavior from governments in the long term, and coordination displayed at the time of stimulus measures in 2009 only lasted a short length of time, while this was not true of the central banks.

In a recent book, Paul De Grauwe suggested that the economy is like a pendulum swing back and forward between market and state in overall management of the economy. An excessive role for the market led to imbalances, which were corrected by greater government intervention as it took back control, leading to imbalances that were only evened out by accepting a greater role for the market…

This type of pendulum swing looks unlikely, but we must be realistic: politics and politicians have taken back greater power in both China and the US, particularly in China. Meanwhile the populist movement in Europe is primarily a political movement, and it seems unlikely that this trend will end soon and for such times as the middle classes do not derive the full benefits of growth.

This post is available in pdf format My Weekly Column – 23 April 2019

The Federal Reserve puts an end to normalization – My weekly column

The post is available in pdf format My Weekly Column – February 4

The US Federal Reserve decided to bring its monetary policy normalization to an end during its meetings on January 29 and 30, 2019.
The interest rate hike cycle had kicked off slowly in December 2015 and stepped up a pace a year later, as nine interest rate hikes pushed the Fed Funds rate up from 0.25% (upper end of range) to 2.5% in December 2018.
During last week’s press conference, the Fed Chair indicated that Fed Funds are now in the range of neutral, in response to the first question from journalists: there is no longer an accommodative or a tightening slant. Powell’s confidence in the strength of the US economy suggests that the end to normalization should not just be seen as hitting the pause button for a while.

The rate hike cycle has been long and slow-moving if we compare to the Fed’s previous series of tightening moves from 2004 for example. A comparison with this period also reveals that real interest rates on Fed funds were much higher then than they are now. The figure is currently marginally above the level witnessed at the start of the normalization process in December 2015, unlike the situation after 2004, when the economy was much more restricted, while this is not the case in the current economic situation.

A comparison of current real interest rates with previous phases of monetary tightening shows that today’s situation is completely different to these episodes.
Real interest rates in November 2018 stood at around 0.4% (inflation figures for December are not yet available on the PCE index), which is much lower than figures in 2006, 1999 or 1990. Does this mean that the US economy is too weak to be able to deal with a real rate above 1%? This would be extremely worrying and would undermine Jerome Powell’s comments that the US economy is in a good place.

It is difficult to understand why US normalization is coming to an end when we look at the economy, as unemployment is near its low, so the central bank should be tightening the reins. The Fed’s projections for 2019 and 2020 are for figures above the country’s potential growth rate and this also fits with the economists’ consensus, at least for 2019. Against this backdrop, monetary policy needs to be tighter to ensure that growth does not create imbalances that then have to be addressed, and this was the message from Powell in 2018, when he suggested that fiscal policy (too aggressive for an economy running on full employment) would need to be offset by tighter monetary policy to rebalance the policy mix. During the press conference on Wednesday January 30, he did not raise this question: the issue was side-stepped, but yet the analysis still remains the same. There are only two possible economic explanations for the halt to normalization: either there are expectations of a severe downgrade to projections when they are updated in March, but this would not be consistent with Powell’s comments; or the Fed is doing whatever it takes to extend the economic cycle at any cost, with the end to the rate hike cycle aimed at cutting back mortgage rates and taking the pressure off the real estate market. However, with the overall economy remaining robust, the risk of this type of move is that it could lead to imbalances that would be difficult to eliminate. This is the opposite approach to the Fed’s strategy right throughout 2018, so it would be a strange tactic.

The inevitable Chinese slowdown – My weekly column

This post is available in pdf format My Weekly Column – January 28th

Growth in China slowed again in 2018, with an average of 6.6% across the year vs. 6.9% in 2017.
This remains a respectable figure, but it is the lowest since 1989 and 1990 as shown in the chart opposite. The 10-year average is also at a low, at around 8%. The 10% that had previously been typical of the Chinese economy is now a thing of the past, and expectations of a shift back to this trend are unrealistic. The Chinese economy is changing, setting the stage for a slower pace of growth. 

A weighty challenge for the world as a whole
Slowing Chinese growth often sets off the warning bells on world growth as a whole. Having hinged on developed countries during the period after the Second World War, growth is now dependent on the situation in China, which has displayed exceptional expansion since the start of the 1990s, creating strong and long-lasting impetus for the world overall.

The world growth driver is now China, rather than developed markets, and this shift is particularly vital as potential growth in developed countries has been on the wane since 2008. Right across the globe, from the US to France, growth that can be sustained in the long term while not generating permanent imbalances is weaker than before the 2007 crisis, and none of these countries can drive strong and self-sustaining growth from within their borders. Meanwhile, China managed to fuel momentum, taking over the role of developed economies – particularly the US – and benefiting the entire world economy.

So China managed to set the stage for stronger growth the world over on a long-term basis, either by sparking fresh competition on the Western markets, developing relationships with other emerging countries (Asia, Africa, Latam) or attracting capital to take advantage of Chinese growth, even if the price to pay for this was the transfer of technology.

According to IMF data (in current dollars terms), Chinese GDP has gone from less than 2% of world GDP in 1991 to 6% ahead of the 2007 crisis and then 16% in 2018, reflecting an astounding acceleration and putting it on a par with the euro area.

Chinese GDP as measured in purchasing power parity – a more coherent price and exchange rate system than the dollar-denominated assessment – has been higher than the US figure since 2014 and above the euro area figure since 2011.

More generally speaking, an increase in the weighting of China was achieved primarily at the expense of Europe and Japan, while the US maintained its strong representation. This also explains why the tension surrounding technological leadership is a Chinese-US matter and excludes Europe, which was not sufficiently involved in supporting China’s swift development.

A final point worth keeping in mind is that Chinese imports equated to close to 80% of US imports in 2017. A domestic Chinese shock affecting its imports would have a similar effect to a shock on US domestic demand and hence on its imports, and the worldwide impact of a shock on Chinese growth would be closer than many would expect to the effects of a shock on US growth.

Why is the euro area slowing? My Weekly column

This post is available in pdf format My weekly column – January 15th

The euro area economy is slowing and could even see a contraction around the end of 2018 due to recessions in Germany and Italy, along with very weak momentum in France. The trend has changed at a faster pace than had been expected at the start of 2018, when the consensus was for similar trends to the very robust growth in 2017 i.e. no acceleration but continued swift economic growth. This pointed to expectations of more self-sustaining growth via jobs, income and investment, thereby driving a more independent trend that could safeguard some of the euro area’s economy against potential external shocks.
This quickening decline is worrying as the situation in a number of countries has gone from solid to shaky, for example Germany, where external trade is now hampering growth, along with Italy and France where domestic demand is no longer on the desired trend.
This quickening decline is worrying as the situation in a number of countries has gone from solid to shaky, for example Germany, where external trade is now hampering growth, along with Italy and France where domestic demand is no longer on the desired trend.

Why this perception of a swift deterioration in the euro area economy?
The first harbinger that all economic observers picked up on is the very swift deterioration in economic indices as measured by business leaders surveys. From a peak in the last quarter of 2017, the composite index slid swiftly and steadily right throughout 2018, failing to display a recovery. This trend is revealed in the euro area Markit manufacturing sector index, which slowed severely and sustainably in sync with world trade, with an accompanying drop in domestic and external orders.