As a behaviourally focused economics publication we have been very quiet and inactive during 2014. A year of reflection and introspection, however, we are ready to resume service, with vigour. And what better way to start than with a reflective piece and thoughts on the biggest risk we believe are developing under the surface without warning. Our concluding theme of 2014 is that of moral hazard.
As Margaret Thatcher once said: “There is no society”; we state today that there is ‘No Moral Hazard’; in fact there is only Moral Hazard PLUS.
We believe that there is a strong correlation between QE (Quantitative Easing) and economic moral hazard developing a new strain, mutating like an unseen virus.
QE might have saved the financial system of the developed world, but it it only provided a shot in the arm and acted as a stimulus for sustaining moral hazard.
Economics follow a flow and cyclical pattern, as discussed in our article entitled ‘Information Age Irony‘. These patterns and flows weave themselves into the fabric of our lives and affect individual economies in different ways.
It is important to understand where and how economic cycles develop and flow and how much influence they have on our general economic activities on a day to day basis, but we should not become overly obsessed by them, as they can be short-circuited from time to time by policy and policy-maker’s actions, wherever individually or collectively.
In part 2 of this article we will focus on the revelations of QE and the underlying threat of moral hazard returning on a grander and more catastrophic scale, if it goes unchecked and misunderstood.
We discovered it unpublished in our web archive today and as the theme is still very relevant today, we decided to publish it:
Today’s brief analysis of US TreasuryYield curves and the Debt profiles of both the USA and Italy highlights the enduring question in the title of this post.
The first graphic highlights one important issue. We chose 2 August 2011 versus 17 February 2012 as key dates to compare the US Treasury Yield curve. If we cast our minds back to 2 August 2012 two key facts emerge:
The key take-away from the Yield Curve comparison is that even with a ratings downgrade, the US is actually able to borrow new capital at a lower rate of interest 6 months on.
However, to pour a bit of realism into the analysis, we highlight two interesting Debt profile graphics below.
The first one is the USA Treasury Maturity curve (admittedly 6 months out of date), highlighting when the current debt will need to be redeemed or rolled over. The second is the Italian Bond Maturity curve. You will notice just how similar the USA and Italy Debt Maturity profiles are.
From this comparison, the critical question currently for us is:
Where will all the new money come from to roll over the debt maturing during the next 3 – 12 months? QE is one option, but investors still need to be convinced that their capital is safe and relatively risk-free. It is the Risk-free equation (or investor risk appetites) that needs to be explored in more detail.
We have been following the G20 ‘get those naughty multinationals in the tax tent’ debates raging for a few months now, with amusement we have to add; here at theMarketSoul and have the following short thought piece to contribute to the debate.
We know the ‘outrage’ really is all about the what the OECD calls the ‘general erosion of the tax base’, which in our opinion is just a distraction for proper structural reforms in the western democracies contributing to the G20 and OECD coffers.
The real issue is the power of civil society structures, such as multinational corporations, versus nation states. We constantly get an earful on how undemocratic corporations are from a liberal social leftist media and how dangerous unfettered corporate power is.
Yet, multinationals are far more democratic, in both structure and performance, than any sovereign government will ever be. If the corporate governance structure is correctly set up, then every corporate entity has an annual AGM at which point the corporate leaders have to resign, on a rotational basis, depending on individual Articles of Association or Memorandum ofIincorporation provisions (depending in which jurisdiction the corporate entity ‘resides’). How often does a sovereign leader stand down, in comparison and leave it to the popular vote to be re-elected? Certainly not on an annual basis, as is the case for most corporate leaders.
This leads us to the real thought piece of this article, namely the fact that corporate ownership and access to corporate ownership should really be extended to as wide a base as possible, rather than a few ‘monied’ or opportunist participants in the market.
Legislation around employee share ownership schemes are still very cumbersome and rules, rather than principles driven.
The real revolution we require is not around a new tax base or recapitalizing democratic bankrupt nation states; however we require a revolution of democratic corporate ownership to sweep the length and breadth of the land, in order to spread the risk, add additional wealth creation opportunities (and hence a widened wealth tax base) for smaller, leaner and meaner governments to address. This a cry from civil society to the inner ‘goodness’ of political society to sit up, take serious stock and work on longer-term solutions to the erosion of their tax bases, rather than the usual headline grabbing short-termist market distorting interventions the G20 governments are so infamous.
There ride will inevitably not be smooth, they never are, with significant volatility in between. However, the Kuznets swing has as an average a run time structure of 15 – 25 years. [Out of interest, the last Kuznets swing lasted 21 years, depending on whether your started counting from “Big Bang“]
Are we prepared for it?
Yes and No might be the correct answer.
No, because we just don’t have the data for it currently.
Yes, possibly, because the effects of a digitised economy is the new unknown. This points us back to our own ‘philosophy‘ page on this site.
More in depth analysis and discussion on the new cycle will follow soon.
We take a brief look at two interesting Treasury Yield curves today.
The first Yield Curve takes a snapshot view of the yield curves at the end of Q1 2011 and Q1 2012.
What is very noticeable is the fact that the overall yields for the end of Q1 2012 is significantly lower than a year ago. Taking a look at the at the 5 year T-Note yields as an example, the spread between the end of March 2011 (5Yr T-Notes at 2.24% ) and the end of March 2012 (5Yr T-Notes at 1.04%) was 1.20% down. The question is what factors drove down the ‘risk-free’ rate on US Treasuries?
However, turning our attention to the second graph below, indicates a slightly different perspective; and hence the title of this post. Has and is risk returning to the capital and stock markets to levels we previously experienced?
Not quite, is the short answer, because the spread between 31 December 2011 (0.83%) versus the 1.04% rate at the end of March 2012, only indicates an uptick of 21 basis points in the yield rate. The significance is not the percentage spread, but rather the direction of movement and we will continue our analysis at the end of Q2 2012 to establish whether the direction in Q1 2012 will be maintained into Q2 and beyond.
The final question to ponder is this:
Are we finally seeing the corner turned, or are there still significant risks in the global economy and sovereign debt markets to cause a few further after shocks in the months to come?