Risk on the rise as political leaders give in to mob rule
FT, October 25, 2011
We are in the midst of a deleveraging, we are nearly out of ammunition and we are at each other’s throats. Being in a deleveraging and nearly out of ammunition is a very difficult position to be in. But, being at each other’s throats is our biggest problem.
Our character and our political and social systems are now being tested in ways that have typically been tested in past deleveragings. In deleveragings bad economic conditions typically lead to emotional reactions, social and political fragmentation, poor decision-making and increased conflict. When this occurs in democracies, the checks and balance system, which is intended to yield the best decisions for the whole, can stand in the way of thoughtful leadership and lead to ineffective “mob” rule. This dynamic can lead to a self-reinforcing downward spiral.
Frustrations increase, the established ways of doing things come under attack and frustrations over the ineffectiveness of government creates the perceived need for someone to gain control of the mess. Plato spoke of this dynamic. It was the reason Hitler was elected in 1933.
In our opinion these types of risks are now emerging and should be taken into consideration when trying to figure out what may lie ahead. Rather than trying to resolve disagreements through thoughtful discourse, people are now trying to grab power to beat and suppress their opponents. Tensions between the rich and the poor, capitalists and socialists, those in and out of power and different factions in each group are now intensifying in a manner that is classic in deleveragings. Politicians who are fighting for power in a political year are fanning the flames and are increasingly willing to do risky things (like shutting down the government) in pursuit of their missions and popular support.
This growing populism will have important implications for monetary, fiscal and trade policies and will significantly increase risks of a markets downturn and a global depression.
Regarding monetary policy, the mob is at the gates of the Federal Reserve and wants to grab control while those on the inside are in disagreement about what should be done. Fed chairman Ben Bernanke and those who helped him save the country from depression are now under siege. These challenges are being faced in different forms by most central banks at the same time as they are nearly out of ammunition – i.e., their capacities to ease are very limited because they cannot stimulate private credit creation and because they cannot get money in the hands of people who will spend it. For these reasons there is greater risk that central banks cannot save us as they have always saved us in the past.
The battle between the left that wants to tax the rich more and the right that wants to cut entitlement spending is at a fierce stalemate that is likely to intensify in more scary ways. As a result, fiscal policy is unlikely to be supportive to economic growth.
With high unemployment and growing anger, the “mob” is blaming the foreigners who “took their jobs,” especially the Chinese who they say are “manipulating” their currency to “compete unfairly”. And since politicians want popular support, they are navigating this issue to gain political benefit (e.g., to put the US President in the position of having to choose between the political suicide of vetoing Senator Charles Schumer’s currency bill and clashing with China) rather than to approach this difficult issue calmly and analytically. Trade flows and capital flows are increasingly being looked at by all sides as possible weapons in an economic war. As a result, the risks of bad surprises in trade and capital flows are heightened.
Mobs are at the doors of bankers and others in the financial system, screaming to politicians to put these people in jail while the vote-seeking politicians are fanning the flames rather than reminding people that the legal system is the way these people should be judged. Since banks are levered about 15 to 1, it doesn’t take much of a debt problem to cause them solvency problems, and since in deleveragings debt problems are big, there is significant risk banks will run out of equity again and the fury against them will intensify. For these reasons risks to the global banking system are much greater than normal.
While we hope that most people and their leaders will approach these difficult challenges calmly and collectively, we would not be meeting our fiduciary responsibilities if we bet on this happening without clear evidence of it. We are not alone in having and expressing our concerns in what has come to be known as “risk-on” and “risk-off” market movements.
If we calm down and work together to properly manage this difficult situation – for example, if we can properly distribute both the austerity and the increased efforts that are required to manage our debt burdens – we can get through this deleveraging without great pain. If we can’t, we may experience an economic, social and political collapse.
Ray Dalio is founder of Bridgewater Associates