15 August 2019

Juan Palenzuela

15 August 2019

Good morning,

On this day in 1971, the United States abandoned the gold standard. It was the last major economy to do so – Britain ditched it in 1931 – meaning that the dollar and the price of gold would no longer be fixed to each other. Instead, they would float independently.
 
By doing so, central bankers had a shiny new tool at their disposal: monetary policy, or the ability to control the money supply. With it, they could now fight deflation and recessions much more effectively by increasing the money supply.
 
For rich countries, the US in particular, abandoning the gold standard also brought the ability to boost growth by borrowing money. Given the power, institutions, and rule of law of the US after World War II, countries around the world were happy to borrow in dollars. But it wasn’t until America set its currency free that the US could reap the full benefits. After that, the country was able to run extremely large fiscal deficits by issuing more and more debt, and in turn pay for that debt with new money. This boosted growth, and also helped the US and the dollar become unrivalled global leaders; all without facing much inflation.
 
For some developing countries, though, adopting fiat (free floating) currencies has not been positive. Many of these countries run large trade deficits, which means that they are net buyers of goods from the rest of the world. This happens because their firms face tough competition to compete abroad and even locally, and so the countries end up importing more goods than they export. To make up for this deficit, these countries have, like their richer peers, tended to borrow from the global markets – mostly in dollars.
 
The result is that they are susceptible to high inflation due to weaker institutions, instability and monetary policy. The temptation to expand the monetary base to boost growth was simply too much to resist; and foreign investors (and local savers) were cautions about their local investments and savings. By definition, this inflation weakens the local currency and appreciates foreign currencies such as the dollars they borrow. As capital leaves the country, developing countries have struggled to pay their debt and are now at risk of defaulting. This is what has been happening to Argentina and Turkey in recent years.
 
Given the usefulness of monetary policy, the gold standard seems unlikely to return. Judy Shelton, one of President Trump’s nominees to fill two influential seats on the Federal Reserve’s board of governors, favours reverting back to it. However, she does not represent the mainstream view.
 
In response, developing countries, including those without current account deficits, need to focus on addressing the issues at hand. The best way forward is to put serious targets on inflation and guaranteeing price stability. A combination of central bank independence, political stability and robust regulatory regimes will be required; a lot of work, but the benefits will be worth it.

News

Labour leader Jeremy Corbyn plans to block a no-deal Brexit by securing a cross-party alliance in the House of Commons and assuming the role of caretaker prime minister for a “strictly time-limited” period. Corbyn has scrapped plans to lead a minority government and promised an immediate general election in a move aimed at breaking the parliamentary deadlock through a no confidence vote in Boris Johnson’s government. The Liberal Democrats – one of the parties the opposition leader hopes to convince, alongside the SNP and rebel Conservatives – have already rejected the idea, saying that Corbyn is not the best option to build a majority against a no-deal Brexit in parliament.
 
Satellite images emerged yesterday showing around 120 Chinese army or police trucks in the Shenzhen Bay Stadium near the Hong Kong border. The pictures, credited to US-based space technology firm Maxar, appear to confirm claims that China is massing troops for an assault on anti-China protests taking place in the autonomous administrative region. Earlier this week, a video retweeted by President Trump showed dozens of trucks driving into the same sports centre, located just off the road that leads to one of the key access routes to Hong Kong.
 
In related news, Trump called China’s president Xi Jinping a “great leader” and offered to arrange a “personal meeting” to solve the intensifying crisis in Hong Kong. White House officials have reportedly been asked to keep a “measured” response to escalating protests in the administrative region over concerns that they could imperil trade negotiations.
 
Argentina’s president Mauricio Macri has announced a package of “relief” measures, including income tax cuts, increases in welfare subsidies, and the freezing of petrol prices for 90 days. The decision comes days after Macri’s shock defeat in the primary elections as a result of the economic recession. The Argentinian leader’s past austerity policies dented his popularity, hindering his chances of winning re-election against the centre-left candidate Alberto Fernández.

Business & Economy

Slowdowns in Germany, China and the US are leading financial markets downwards, prompting investors to dump shares and buy safer government bonds. The possibility of the German economy sliding into recession and the US-China trade conflict are fuelling the sense of panic, with many analysts arguing that the global economy may be experiencing an uncontrolled decline in growth. The ongoing tariff war has damaged exporting countries in Europe, halving the growth rate of the 19-member eurozone currency bloc from 0.4% in the previous quarter to 0.2%.
 
Huawei has said it is confident that the UK will resist “politically motivated” pressure from the US government over the Chinese telecommunication firm’s investment in 5G mobile internet infrastructure in the country. In case of a negative ruling from the UK government, Huawei’s president of global government affairs Victor Zhang said that the company will continue to invest and create jobs in the UK. The move comes after the US warned its allies that the use of Huawei’s components in critical infrastructure is a threat to their national security.
 
Nancy Pelosi, the US house speaker, has warned that a free trade deal between the US and the UK is unlikely to pass Congress if the UK’s withdrawal from the EU undermines the Good Friday Agreement or the open Irish border. Pelosi insisted that the agreement reached between the UK and Republic of Ireland will be “fiercely defended” by both Democrat and Republican members of Congress. Meanwhile, the pro-Brexit Trump administration has promised Boris Johnson deal which is unprecedented in scope.

Markets

What happened yesterday?

London shares were sharply lower at close of play on Wednesday. The FTSE 100 finished down 1.42% at 7,147.88, while the pound was stronger against the dollar by 0.04% at $1.20 and the euro by 0.32% at €1.08. This was the result of the latest inflation data, which saw the Bank of England overshoot its two per cent target.
 
In corporate news, Sports Direct (down 10.01%) plummeted after announcing that its auditor for more than a decade, Grant Thornton, had quit, leaving the retailer less than a month to find a replacement.
 
Auto Trader (down 0.65%) was also among the fallers following Volkswagen’s plans to bring its used car website, Heycar, to the British market.
 
On the upside, Admiral (up 4.08%) rose as it revealed a four per cent increase in interim pre-tax profits, while construction group Balfour Beatty (up 9.32%) rallied after reporting a jump in first-half pre-tax profit, promising to deliver a full-year performance in line with market expectations.
 
In the US, equities fell three per cent after disappointing data from China and Germany increased fears of a global slowdown and recession. The S&P 500 index and the tech-heavy Nasdaq Composite fell by 2.9% and three per cent respectively.

What's happening today?

Interims
Georgia Capital
GVC Holdings
KAZ Minerals
Marshalls
TBC Bank Group
 
Trading Announcements
Gem Diamonds Di

UK Economic Announcements
(09:30) Retail Sales

Int. Economic Announcements
(10:00) GDP (Preliminary) (EU)
(13:30) Retail Sales (US)
(13:30) Philadelphia Fed Index (US)
(13:30) Initial Jobless Claims (US)
(13:30) Continuing Claims (US)
(14:15) Industrial Production (US)
(14:15) Capacity Utilisation (US)
(15:00) Business Inventories (US)

Columns of Note

Writing in The Times, John Bache calls for more magistrates before extra police officers are recruited throughout Britain, as part of a plan by Boris Johnson. Courts are under increasing strain, mainly because the vast majority of criminal cases are dealt with entirely in magistrates’ courts. With more cases emerging, a shortage of magistrates has created a critical bottleneck. The number of magistrates in the UK is down to 15,000 from almost 30,000 a decade ago, driven by a failure to recruit in sufficient numbers. (£)
 
In the Financial TimesDavid Pilling explains why Zimbabwe’s political crisis has turned out worse than expected. Although overall incompetence is to blame, the new government’s decision to ban the use of the dollar in June, which was convertible on a one to one basis to the local currency, is one of the main failures. Since then, the zollar has lost most of its value, decimating savings and scaring away investors. Despite this, Zimbabwe remains one of Africa’s brightest prospects. Its people are among the best educated in the continent and many of them, now in exile, are waiting to return should the Zanu-PF party vacate power after decades of mismanagement. (£)

Did you know?

Between 1600 and 1725, most pirates operated under a Crown Commission which called them privateers and gave them official license to attack and loot enemy ships, mainly French and Spanish. Their “work” was essential for Britain’s war efforts during this period.

Parliamentary highlights

House of Commons
In recess until 3rd September
 
House of Lords
In recess until 3rd September
 
Scottish Parliament
In recess until 2nd September