Covid Uncertainties

Doug Nolan

It significantly raises the stakes for a potential nightmare scenario: with less than five weeks until election day, the President contracts COVID-19. As if this election cycle wasn’t chaotic enough. 

As CNN put it: 

“A stunning new twist in a tumultuous year, throwing an election that is only 32 days away into chaos and raising the grave possibility of more American crises over governance and national security at an already perilous moment.” 

And from the Wall Street Journal: 

“The law of unknown consequences now is in full effect. The uncertainty starts, of course, with the actual state of the president’s health going forward. In the coronavirus pandemic, the world has seen that the difference between a mild case and severe reactions can be an enormous one.”

Whether it’s the recession, Credit issues, COVID consequences more generally, or even the President’s illness – markets have been well-conditioned for “mild case.” The S&P500 ended Friday’s session down just under 1% (broader market actually closed higher on the day), a notably mild reaction to such a potentially destabilizing development. 

The perceived higher likelihood of a stimulus deal helped underpin financial markets. A Friday evening Bloomberg headline: “Escalating Chaos Again Proves Incapable of Derailing the S&P 500.”

Clearly, markets have grown comfortable seeing bad news in positive light. But to see the President – less than 24 from his positive test result - board Marine One for a planned several-day stay at Walter Reed Medical Center is unsettling to say the least.

A phenomenal market backdrop has become only more so. Let’s take the analysis back a year as we strive for an informed perspective. Federal Reserve Credit jumped $170 billion (to $3.946 TN) in the four weeks preceding October 2, 2019 – as the Fed restarted QE in response to heightened repo market instability. Fed Credit expanded an additional $252 billion between October and February 19th.

Bloomberg’s Tom Keene (September 23, 2020 TV interview): “It’s all great. I look at the Fed policy and the hope and the prayer. But the great conundrum out there… is this fear of asset Bubbles. Is a consumer discretionary stock with a 32 P/E the definition of an asset Bubble? …Are these asset Bubbles?”

Mike Schumacher – Wells Fargo Securities Head of Macro Strategy: “The Bubble term is interesting. People talk about it quite a bit. It’s hard to define it. What exactly is a Bubble? To me a bubble is something where prices explode upward with no tie to fundamentals and no clear link to policy changes. And what we’ve had in the last six months is a little different, because policy shifts have really boosted assets dramatically. So, I’d say it’s too soon to tell the Federal Reserve or the ECB that they’ve really put forth a Bubble. But that could happen in six or twelve months.” 

“A bubble is something where prices explode upward with no tie to fundamentals and no clear link to policy changes.” There’s a big hole in this definition: Government policies typically play an instrumental role in Bubble Dynamics.

Fed Credit has expanded $3.294 TN over the past 56 weeks, an unprecedented expansion of central bank liquidity. Did the Fed further inflate a historic speculative Bubble, exacerbating market and economic fragilities heading into a pivotal election?

It is almost universally accepted the Fed has acted responsibly and effectively in countering negative pandemic effects. Markets remain near all-time highs in the face of economic weakness and myriad uncertainties. Booming equities and Credit markets have provided powerful underpinnings to the real economy.

For most, the Bubble debate is not even relevant. General sentiments are harmonious with Treasury Secretary Steven Mnuchin’s comments from a couple weeks back: “Now is not the time to worry about shrinking the deficit or shrinking the Fed balance sheet. There was a time when the Fed was shrinking the balance sheet and coming back to normal. 

The good news is that gave them a lot of room to increase the balance sheet, which they did. And I think both the monetary policy working with fiscal policy and what we were able to get done in an unprecedented way with Congress is the reason the economy is doing better.”

I had serious issues last September when the Fed introduced this notion of “insurance” monetary stimulus, moving forward with aggressive measures despite stocks near record highs and unemployment at 50-year lows. It was a move that clearly risked ratcheting up already severe market distortions. 

Then in January the risk of a highly problematic global pandemic became increasingly apparent. 

U.S. equities, however, completely disregarded this risk well into February (record highs on Feb. 19th). The S&P500 returned 16.7% between September 1st and February 19th, with the Nasdaq100 up 27%. 

Were Fed stimulus measures responsible for extraordinary pre-COVID market gains? Did the restart of QE contribute to market COVID complacency? 

And most pertinent to this analysis, did the powerful advance and risk complacency contribute meaningfully to latent market fragility? 

Or, more directly, did a Fed-orchestrated Bubble create a dangerous speculative market dynamic whereby risks were disregarded until reaching a point where the dam broke and crash dynamics erupted? Did “policy changes” directly contribute to acute Bubble fragilities and a near market breakdown?

The VIX index traded as low as 14.49 on February 20th – a remarkably depressed level considering escalating pandemic risks. I would strongly argue the low cost of market “insurance” was a direct consequence of the Fed’s September adoption of an “insurance” policy stimulus approach. Why not sell put options and other market derivatives insurance with the Fed committed to moving early and aggressively to counter nascent market instability? 

I’ve over the years used a flood insurance analogy in an attempt to underscore anomalies in market “insurance.” It was as if in February the cost of flood insurance remained unusually cheap in the face of torrential rainfall – knowing the barriers local authorities had erected up the river were restricting the water-flow. 

The longer a Bubble’s duration the easier it becomes to rebut its existence. Meanwhile, Bubble effects over time become more structural. Protracted bull markets crystallize perceptions, while financial innovation ensures myriad instruments and strategies that work to perpetuate bullish flows and trading dynamics. 

There becomes little doubt. It’s best to remain fully invested. Managed risk, not by adjusting portfolio composition but with options and other derivatives. “All weather” portfolios can be structured with Treasuries and other diversification tools functioning as internal hedges. And, in the event of acute market instability, there are myriad highly liquid ETFs that can be immediately shorted (or, in other cases, purchased) to efficiently hedge market risk.

Given time, risk embracement ensures mighty and unflagging flows into the risk markets. The bull market functions elegantly – validating perceptions of robust fundamentals and market conditions. Risks are downplayed, with complacency reinforced by readily available risk insurance and risk-mitigation strategies. It all works miraculously until it doesn’t - until the eventual disruptive eruption of “risk off” de-risking/deleveraging. 

It is impossible for “the market” to offload risk. Any time a meaningful segment of the marketplace seeks to de-risk there becomes the critical issue of who has the wherewithal to “take the other side of the trade.” 

With market “insurance” remaining so inexpensive, it made sense back in January and February to maintain a “risk on” posture while also purchasing put options and other derivatives to hedge potential pandemic risks. Yet the accumulation of huge quantities of option protection created vulnerability to downside market dislocation. If large amounts of flood insurance were purchased and then the dam breaks – it immediately becomes a systemic issue. 

When pandemic risk materialized (economic lockdowns, acute uncertainty and fear), those that had sold market insurance rushed to sell underlying instruments (futures, stocks, ETFs, etc.) to (dynamically/“delta”) hedge their rapidly expanding risk exposures. At the same time, a highly speculative market experienced an abrupt bout of liquidation. 

All the plans to sell highly liquid (equities and corporate bond) ETF shares – the liquidation of speculative long positions and hedging-related shorting - quickly sparked illiquidity, dislocation and panic.

What did we learn from such a terrifying experience? That “whatever it takes” Federal Reserve measures will embrace trillions of liquidity creation; the Fed is willing to expand purchases to include corporate bonds, ETF shares and, surely at some point, stocks; there are no longer limits to the type and scope of various Fed special financing vehicles; and the Federal Reserve is willing to greatly expand the scope of international swap arrangements. 

We’re now a month away from pivotal elections with a high probability of general chaos, contested outcomes, and protracted uncertainty and instability. And now the President is in the hospital with COVID; infections are mounting within the government ranks; and general disarray has engulfed Washington. At about 3,350, the S&P500 remains within striking distance of last month’s all-time high. 

The bottom line: The November 3rd election could be the most heavily hedged-against event in market history. Moreover, the most hedged event comes in the most speculative of market backdrops – which follows history’s greatest expansion of central bank liquidity. Tinderbox. 

The marketplace has had months to purchase put options and other derivatives “insurance.” Too much of the marketplace has acquired products or adopted trading strategies that are expected to offload risk in the event of a meaningful market drop. 

In the event of negative developments and a resulting market downturn, massive sell-programs would kick in as sellers of market insurance move to hedge escalating risks. Moreover, an extraordinarily speculative market is susceptible to any shift in risk tolerance. 

In short, the potential for a self-reinforcing cascade of selling and market dislocation is today even greater than March.

Why do markets remain so dismissive of election-related risks and latent market fragility? The Fed, of course. And this has created a dangerous dynamic. Markets have become completely incapable of adjustment and correction. The nightmare scenario would see problematic developments, market dislocation, and Fed impotency in the face of acute market instability. 

Markets, of course, have faith in “whatever it takes”, ensuring nightmares don’t become reality. 

But years of QE and bailouts (certainly including March) have nurtured a high-risk Bubble backdrop with the potential for mayhem.

Markets needed to have been left to stand on their own. The pandemic unleashed myriad risks – including market and economic dislocation, social upheaval and, even, the President and top government officials becoming ill. The pandemic elevated the risk of social, political and geopolitical instability. And it was not the Fed’s role to have so numbed the markets to risk. Such numbness has only exacerbated market and financial fragilities. 

We’re now living the perilous consequence of the Fed using the securities markets as its key mechanism for system reflation. The system would today be less fragile had air been allowed to come out of equities and corporate bond Bubbles. Instead, highly inflated Bubbles create increasingly unwieldy risk dynamics in a pandemic backdrop of extraordinary instability and uncertainty. 

We’re about a month from a potentially cataclysmic market reaction in the event of a highly unfavorable election outcome. I’ve written this in the past. 

Contemporary finance works miraculously so long as financial claims and asset prices continue inflating. It just doesn’t function well in reverse. And, importantly, the degree of dysfunction worsens after every repeated market bailout and resulting speculative Bubble resurgence. 

Bloomberg’s Lisa Abramowicz: “Fund manager after fund manager has come on this show and said that we are at risk of creating an asset price Bubble if not having created it already. How does that factor into your calculus about when to tighten policy?”

Federal Reserve Vice Chairman Richard Clarida: “Well, that’s a good question, and obviously financial stability is always – and certainly as Powell said – an important consideration. We get regular briefings on financial stability. We issue a twice-yearly report, and we’re very attentive and attuned to that risk. But it’s also important to remember, Lisa, we have a dual mandate assigned from Congress which is maximum employment and price stability. If, hypothetically, we were to become concerned that financial stability put our maximum employment and price stability goals at risk, then we’d have to factor that in. But Lisa, we also believe that monetary policy – raising or lowering rates – is a pretty blunt instrument. And our inclination and our preference at the Fed is to work with other agencies on regulation, supervision, bank liquidity and other dimensions than simply raising or lowering rates to deal with financial stability.”

“If… financial stability put our maximum employment and price stability goals at risk…” “A consideration”? 

Clarida’s comment gets right to the heart of the problem. 

Financial stability should never have been subordinate to prices and employment; it is, instead, the overarching mandate to be nurtured and safeguarded with intense focus and steadfast resolve. 

We’re today in the most financially unstable environment of my over 30 years of analysis. 

Hopefully the President recovers quickly, the election goes smoothly, the pandemic abates, social tensions subside, and a semblance of normalcy returns. 

But even in the unlikely event of a series of best-case outcomes, this historic Bubble will continue to overhang financial stability.

US Treasury market’s brush with disaster must never be repeated

Fed tamed the chaos in March but must take further action to buttress future solidity

Robin Wigglesworth 

The Federal Reserve was forced to intervene even more aggressively in March than it did in the financial crisis of 2008, but more action is required © AP

The US government bond market is akin to the investment world’s bomb shelter, a safe space where everyone can seek refuge when the rest of the financial system is exploding. In March, the bomb shelter itself started to rumble ominously. 

Treasuries are easily the biggest and most traded fixed-income securities on earth. Thanks to their safety, liquidity and the American dollar’s status as the global reserve currency, they are the world’s “risk-free” rate, the default haven, and facilitate a vast amount of financial transactions.

However, the coronavirus crisis caused trading conditions in the normally well-behaved US government bond market to deteriorate dramatically in March.

The dislocations were so bad that the Federal Reserve was forced to intervene even more aggressively than it did in the financial crisis of 2008.

This kind of chaos should not be allowed to happen in such a vital part of the financial system. Although it would probably have settled down eventually — there are always buyers of Treasuries at some point — it could have caused cataclysmic accidents along the way.

The danger is that the swift market recovery engineered by the Fed’s extraordinary actions makes us forget how close Treasury trading came to breaking down in March, and blunts efforts to understand what happened — and ensure it never happens again. 

The disruptions were caused by the collision of several, often interlocking factors: the post-crisis regulatory architecture for banks, the rise of algorithmic bond trading, a frenzied dash for cash triggered by the coronavirus crisis and hedge funds that exploit tiny arbitrage opportunities in government debt markets.

Stricter regulations have forced banks to curtail their own trading and act more as brokers intermediating trades between clients. This is obviously positive but has contributed to more high-speed electronic trading and opened up opportunities for less-regulated hedge funds.

One popular strategy is to exploit pricing differences between Treasury bonds and Treasury futures, a “basis trade” that requires massive dollops of leverage to turn small discrepancies into healthy, consistent profits.

However, when Covid-19 triggered a global scramble for cash, including ditching Treasuries, the modern trading ecosystem was unable to cope with the selling spree. 

Treasury yields jumped and the spread between Treasury futures and bonds ballooned. 

This in turn triggered margin calls for hedge funds that had borrowed hundreds of billions of dollars in the short-term “repo” market to bet on the difference narrowing, exacerbating the dislocation.

Fearing a mass unwinding of the entire basis trade — which would have caused even more Treasuries to be dumped, worsening the chaos and potentially even imperilling the government’s ability to smoothly fund itself — the Fed acted decisively. Today, the volatility of the Treasury market is near the lowest in history. 

However, the events of March cast a long shadow. Although the Fed’s actions were spot on, its backstop was akin to a bailout of the basis trade. It has been tamed for now but eventually hedge funds might be encouraged to use even more leverage to enhance the strategy’s returns, knowing the Fed has their back in case of another accident. 

Even in the hedge fund industry, there are concerns about the consequences. “The moral hazard is massive, and the regulators have to structurally address it”, the head of one of big hedge fund recently told me. “The brittleness [basis trades] create is a massive problem.”

Of course, not everyone thinks the Treasury dislocations are a major concern, arguing that they reflected the unique scale and abruptness of the shock rather than structural fragilities. Notably, there were no operational outages, nor a big spike in failed repo trades, Even among analysts who do think it revealed dangerous faultlines, few can agree on what the weightiest factors were.

For example, a soon-to-be-published paper by Marco Di Maggio, of Harvard Business School, argues that the aggregate Treasury positions of basis-trading hedge funds were too small to matter. Instead, he pins blame on the Treasury fire sale simply overwhelming banks’ ability to ensure orderly markets. 

Prof Di Maggio acknowledges financial support from the Managed Funds Association, a hedge fund industry trade body that also reviewed the paper before publication.

Whatever the causes, what can be done to buttress the Treasury market’s solidity? 

Darrell Duffie, of Stanford University, advocates for mandatory central clearing of all Treasury trades, a move that is arguably overdue. But something more drastic is warranted. Regulators could also impose fixed “haircuts” on repo loans to limit how much leverage hedge funds and other investors can use in the Treasury market.

The Treasury market is simply too important to be left to its own devices. 

Week in charts

Biden and business

Germany’s 30th rebirthday • The covid-19 housing boom • India, Pakistan and the pandemic • Famine in Yemen

THE NEWS that President Donald Trump had tested positive for covid-19 capped another astonishing week in America’s presidential campaign, following revelations in the New York Times about his paltry tax payments and hefty debts, and an ill-tempered debate in Cleveland. 

It is too soon to tell how the president’s diagnosis might affect the race, much beyond ruling out his planned visit to Florida on Friday. But as things stand, our model suggests that were the election held today his Democratic opponent, Joe Biden, would be very likely to win. 

On the cover this week, we examine what a Biden presidency might mean for the American economy. Mr Trump claims, and some businessmen fear, that Mr Biden would tack hard to the left. 

That looks improbable. 

Mr Biden’s formal spending plans amount to 3% of GDP, against the 16-23% pitched by his defeated left-wing rivals for the Democrats’ nomination. 

In fact, in some respects—on prising open monopolies, or turning back Mr Trump’s protectionism—Mr Biden does not look bold enough. A lifelong pragmatist is likely to govern as one.


On Saturday Germans mark the 30th anniversary of the reunification of their country. 

Divisions between east and west Germany are still plain (eg, for women in the labour market). 

Yet reunification has been a resounding success, despite the misgivings of other European countries in 1990 about a possibly dominant Germany at the heart of the continent, and despite the crises of the past dozen years in global finance and the euro area, and over migration. 

Even so, western Europe’s biggest power has been too cautious on the international stage. 

In its relations with China and Russia it has put commercial interests before geopolitical ones (notably over Nord Stream 2, a gas pipeline linking it to Russia). 

There are welcome signs of a shift, in dealings with those countries and (in economic policy) with its partners in the euro zone. 

But Germany has much more to do.


The world’s economies have been blighted by the pandemic. 

Yet despite a rocky September its stockmarkets have been remarkably resilient. So have markets for another, bigger asset class: housing. 

In the rich world, house prices rose by 5% in the second quarter. 

They have been supported by the same ultra-low interest rates that have helped stockmarkets, by governments’ support for people’s incomes during the pandemic and by greater demand for living space as more people work at home. 

But the boom makes life harder for young, would-be homebuyers. 

It is another unequal effect of the pandemic, which could intensify intergenerational tensions already visible in the 2010s.


Another covid-19 curiosity is the contrast in the fortunes of two South Asian neighbours. 

Officially, the disease has killed 6,500 Pakistanis in all. 

Lately India (with a population only four times bigger) has been losing more lives than that every week. Odder still, Pakistan is poorer and its health-care system flimsier. 

But its people are also younger. 

Indians’ relative prosperity (and hence mobility) may ironically have left them more exposed. 

Both countries’ true caseloads, though, may far exceed the official tally. 

Elsewhere, grim news continues to roll in. 

In severely hit Peru, ill-informed self-medication is adding to the virus’s toll. 

In Iraq doctors have been beaten up and religious leaders continue to organise mass gatherings. 

And in Europe’s second wave, Spain is again the worst-hit, with its politics also infected.


Perhaps nowhere is worse-placed to withstand the pandemic than Yemen. 

Covid-19 is spreading unchecked in a country torn for the past six years by a war between the government, backed by Saudi Arabia, and Houthi rebels, backed by Iran, that has killed tens of thousands. 

A rusting oil tanker off the west coast is an ecological disaster in waiting. Yemen’s most urgent problem is famine. 

Two-thirds of its 30m people need food aid; millions, says the UN, are at risk of starving. 

Famine could be prevented. But the Saudis and others have cut back promises of aid. 

And the combatants show little more sign of caring about the plight of Yemen’s people.

The Economic Case for Biden

US President Donald Trump has seeded the investment environment with uncertainty, trashed America's trade relationships, blown up the fiscal deficit, and left American workers worse off than they were when he took office. He is the polar opposite of Joe Biden, a politician who understands precisely what the US economy needs.

Edmund S. Phelps

NEW YORK – Commentators have offered many reasons why one should vote in November for Joe Biden, the Democratic nominee for US president. Yet the economic dimension of the election has been of little interest to pundits, and few, if any, economists speaking on the subject have bothered to highlight how the outcome bears directly on people’s welfare. 

But the economy is the stage on which people work in the hope of gaining personal development and the satisfaction of succeeding. It isn’t just about the money.

The economic case for Biden begins with the economic case against President Donald Trump. Consider Trump’s costly corporate tax cut. It did not deliver anything like the investment and growth he promised, and the main effect was to run up fiscal deficits in the first three years of his presidency.

Trump’s disregard for this fiscal profligacy has set a precedent for unnecessary deficits in future administrations. (Of course, the deficit incurred more recently in responding to the pandemic was unavoidable and, under the circumstances, beneficial.)

His habitual threats to American businesses have added new uncertainty to investment and trade decisions. He practices Mussolini’s doctrine of corporatism: the government as puppet master pulling the strings of puppet companies. That economic policy inhibits enterprise and innovation at a time when they are desperately needed.

Trump’s misguided crusade to reduce the harmless trade deficit has shrunk world trade, thus worsening the efficiency of resource allocation at home and abroad.

His populist rhetoric has not translated into better pay for less advantaged workers or victims of discrimination. He has sought to erase any sense of economic justice. He cares nothing about the appallingly low wage rates for those at the bottom or about the terrible living standards that these wages afford. 

And he has done nothing to support the eradication of statistical discrimination – racial, gender, and LGBT+. His weakening of the Affordable Care Act (Obamacare) has heavily affected people with low incomes.

Trump’s insistence that climate change is a hoax has put the world economy and the viability of the planet in further danger. He says that the wildfires ravaging the American West are the result of poor “forest management.” 

He has depreciated American soldiers’ heroism and sacrifice, and has no appreciation or understanding that the economy needs people’s heroism to dream up new ideas and risk investing in their development and market entry.

In attacking institutions from the FBI to the US Centers for Disease Control and Prevention, Trump is hollowing out the governmental structure. In imposing pointless obstacles that lead to trade wars, he has alienated America’s allies. 

In his admiration for dictators and authoritarian leaders, he is helping them to establish twenty-first-century fascism. And his chronic lying from the Office of the President undermines the people’s confidence in their government.

There are other outrages too numerous to mention. But one of the most appalling was his effort to eliminate the so-called DACA program for undocumented aliens who were brought to the US as children, who, after being raised and educated in America, now face deportation. Yet another outrage is his tactic of instilling fear of reprisals and arrest. As a result, there is a growing climate of anxiety and distrust.

Today, a great many people support Biden on these grounds and others. Trump stands in the way of the nation regaining a sense of flourishing, equity, and social harmony. But it is not clear that he could be defeated on these grounds alone. Many Americans dread a government devoted to ministering to a mélange of social groups without a thought to core matters of economic growth and job satisfaction.

But there is also a positive argument for supporting Biden.

First, Biden understands that in America there is still a crushing disparity between the wages of the seriously less-advantaged and those paid to middle-income people – and payments for single mothers do not change that. Biden, having grown up in the steelmaking region of Pennsylvania, can hardly be blind to the deprivations and pain of low-paid workers. So, if elected, we would have a president responsive to legislative initiatives for subsidies designed to pull up these workers’ meager compensation.

Biden is also attentive to the existential threat of continuing climate change. There is a vast litany of problems, such as the burning of fossil fuels causing increased levels of carbon dioxide and rising temperatures. 

Addressing these problems will require government intervention and international cooperation, such as that mandated by the 2015 Paris climate agreement, from which Trump withdrew the US. No one can doubt that, if elected, Biden would be eager to play a central role in the resumption of the battle against global warming.

Finally, Americans are living with the virtual stagnation of the economy since the early 1970s (interrupted for about a decade by the Information Revolution). This continuing malaise lies behind wage earners’ increased frustration over their relative standing in wage distribution – a sentiment that, more than anything else, accounted for Trump’s rise. There can be no question that a President Biden – unlike President Trump – would want to restore the economy to its former glory.

For all these reasons, it is vitally important that the people vote for the Biden-Harris ticket. Trump has gravely weakened the nation’s economy, while Biden has shown over his life that he cares about people’s chances for prosperity and rewarding lives – for achieving the American Dream.

Edmund S. Phelps, the 2006 Nobel laureate in economics and Director of the Center on Capitalism and Society at Columbia University, is author of Mass Flourishing and co-author of Dynamism. 

Belarus’ Next Episode 

By: George Friedman



Public demonstrations against Belarusian President Alexander Lukashenko have intensified. Looked at casually, it seems unlikely that his presidency can survive. If the protesters are as dedicated as they appear, then Lukashenko has run out of maneuvering room. The only solution to an intense and long-term resistance is an armed force that will shoot into the crowd. Since the protests have gone on for weeks and that hasn’t happened, the demonstrators’ calculation is that it won’t happen.

Lukashenko’s only option to remain in power, therefore, is to change the game His meeting with Russian President Vladimir Putin in Sochi on Monday was an attempt to do just that and, along the way, allow Putin to change his game as well.

Lukashenko has been skilled in preserving Belarusian sovereignty and, by doing so, preserving his own power. At this point, sovereignty is a luxury he may no longer be able to afford. 

Given the limits of Belarusian forces to suppress the demonstrations, Lukashenko’s last chance to survive is to trade sovereignty for real but diminished power by entrusting someone else to put down the unrest. And the most obvious potential partner is Putin.

Putin has, as we have written about extensively, a central interest in integrating Belarus into the Russian sphere. Belarus is not only a defensive asset for Russia, providing a buffer and strategic depth against Western intrusions, but also an offensive threat, when in Russian hands and housing Russian forces, to Poland, the Baltics and, in the longer term, Slovakia. 

Putin does not intend to launch a war westward. The odds of his losing such a war are too high to risk, and the result of a loss would be unpredictable. 

For Putin, merely having the option of war gives him political standing in Russia and a lever that could force European countries to change their policies to accommodate Russian needs. 

Belarus would give Russia options, and strategic options are fewer in practice than they might appear in theory.

Belarus at a Crossroads
(click to enlarge)

Putin has been maneuvering to dominate Belarus for a long time, but Lukashenko has blocked him. Putin had little to offer Lukashenko, and outright military occupation, although something the Russians could succeed in doing, would resurrect NATO as an effective fighting force and cause Germany to back off from stronger ties to Russia. The latter two things took priority over Belarus, so Russia nibbled but couldn’t act.

The Belarusian election and the public's response give Putin the option to act. Rather than a hostile intrusion, he would be coming at the request of the legally elected president of Belarus, to stabilize a country of vital interest to Russia, in a time in which Western agitators are creating a crisis for Belarus. 

Putin would not have to use force; the mere presence of Russian forces would signal to the Belarusian demonstrators that the risks of protesting suddenly increased. The Sochi talks helped establish steps in this direction: Lukashenko suggested that Belarus’ future military drills, no matter the size or scope, should include Russia, while Putin announced that Moscow would be giving Belarus a $1.5 billion state loan.

Though it’s unclear whether the poisoning of Russian opposition leader Alexei Navalny was meant as a signal to Belarus of what might come – and indeed, that seems too neat an explanation – certainly a move on Belarus would be a signal to Putin’s own opponents in Russia.

It’s also unclear how strong the demonstrators are. We don’t know whether they could or would resort to armed resistance, or if neighbors like Poland might help them. Measuring the distribution of power between demonstrators and governments is one of the hardest parts of geopolitics, because it is not geopolitical. 

Many years ago, I underestimated the demonstrations in Iran, and failed to see that a large faction of the Iranian army was standing beside the demonstrations. But I also thought the crowds in Venezuela would bring down Nicolas Maduro. 

Measuring the passion of a crowd and the discipline of the police and military is not easily done. And the tendency of politicians and pundits to guess wrong is substantial.

This is something that Lukashenko and Putin must calculate. Attacking a mass of people willing to face their bullets would be devastating to both – for Lukashenko because he would lose complete control of this people, and for Putin because he would lose Europe’s support, which he badly needs.

Still, crowds often defeat powers that are already collapsing, like the shah. So Lukashenko, with much at stake, will offer Putin a lot. Putin, with much to gain, will be eager for the benefit, but will be the more cautious of the two. 

He will want to take control of Belarus without appearing to have violated its sovereignty. How that works was likely after-dinner conversation.



Can you make money from the Big Mac index?

Arbitrageurs have long sought to exploit the idea of purchasing-power parity

This week Hong Kong’s monetary officials stepped into the foreign-exchange markets after dusk to defend the city’s long-standing peg to the dollar. 

Given everything the financial hub has faced in recent months—protests, a pandemic and punitive American sanctions—you might assume it is battling to prop its currency up. 

You would be wrong. The city’s monetary authority has been forced to sell Hong Kong dollars repeatedly since April to stop the currency strengthening too much.

This resilience must be a little uncomfortable for prominent speculators, like Kyle Bass of Hayman Capital Management, a hedge fund, who have predicted a catastrophic devaluation. But it will be no surprise to followers of our Big Mac index. 

The tongue-in-cheek guide to the fair value of currencies showed that the Hong Kong dollar was undervalued by almost 54% in July. 

That suggests no urgent need for it to fall.

The Big Mac index is a simple illustration of purchasing-power parity (PPP), the notion that the fair value of a currency should reflect its power to buy goods and services. 

It took HK$20.50 to buy a Big Mac in Hong Kong in July and $5.71 to buy one in America. 

The exchange rate that would equalise their burger-buying power was therefore HK$3.59 to the dollar. That is substantially stronger than the actual exchange rate of HK$7.75.

What practical guidance, then, can the Big Mac index offer to currency speculators? 

Economists reckon that modest deviations from fair value halve every one to three years or so. 

Suppose that an investor had bought the most undervalued currency in our index, which we publish each January and July, and then sold it two years later. How would they have fared?

Not well, is the short answer. 

Imagine that our hypothetical punter invested $10 each time. Of the past 15 completed bets, ten would have lost money (ignoring interest and inflation). The investor would have bought the Indian rupee in January 2013 only to see it fall by 13% against the dollar over the next two years. 

Ukraine’s hryvnia was the most undervalued currency in July 2014, after which it proceeded to halve in value. For a total outlay of $150, our punter would have ended up with less than $138 (although they could have made another $20 or so in interest on their currency deposits, over and above the cost of borrowing in dollars).

Although not great for an investor’s wealth, these results are not quite as damaging to the idea of PPP as they first appear. 

Deviations from PPP can narrow in two ways: through fluctuations in the exchange rate or via movements in prices. 

In India, for example, the price of a Maharaja Mac (which McDonald’s serves in place of a beefy Big Mac) rose much faster than that of an American Big Mac from January 2013 to January 2015. 

That rise in price more than made up for the fall in the rupee, leaving India less undervalued. The same is true in four of the other nine losing currency bets.

Believers in PPP also accept that rich countries tend to be more expensive than poor ones, because their wages are higher even in parts of the economy that are not terribly productive. 

So The Economist also calculates an adjusted Big Mac index, which shows whether a burger is cheaper or dearer than you would expect given a country’s level of GDP per person.

Is this adjusted index a better guide to currency speculators? A similar strategy of buying the cheapest currency in the index and selling it two years later would have paid off on 12 out of 15 occasions since July 2011. 

In all but one case (buying Russia’s rouble in January 2016), though, gains would have been small. That is because the most undervalued economy in this version of the index is, more often than not, Hong Kong. And despite hedge-fund histrionics, betting on its currency against the dollar typically poses little risk—and offers little reward.

This Big Mac back-test is mostly a bit of fun. But the results are broadly in line with more sophisticated research. 

In 2011 Gianfranco Forte of the University of Milano-Bicocca, Jacopo Mattei of the University of Ferrara and Edmondo Tudini of Bocconi University showed that simple PPP-based trading strategies yielded respectable, if unspectacular, returns (although their test did not include currencies as edgy as the hryvnia). 

“Few empirically literate economists take PPP seriously as a short-term proposition,” Ken Rogoff of Harvard University once pointed out, but most believe it has some anchoring power over the long run. 

It gives investors something to chew on. But it’s not fast food.