Democracy in a time of division

The challenge for Joe Biden is to convince most US citizens he serves their interests

Martin Wolf

    © James Ferguson

The election of Joe Biden as US president is the first good news for embattled believers in liberal democracy and the postwar multilateral order since 2016. He is a decent man with an instinctive grasp of the values America has, at its best, stood for. 

On the assumption that Donald Trump’s attack on the electoral process fails, Mr Biden will be president. That will be a huge relief. But it is folly to imagine that Trumpist division is defeated.

More broadly, liberal democracy will remain embattled, in the US and elsewhere. The evidence on this reality is, alas, clear. Research at the Centre for the Future of Democracy at Cambridge university shows a rise in global dissatisfaction with democracy since shortly before the 2008 financial crisis. The rise in dissatisfaction in the English-speaking democracies, led by the US, is striking. 

Frighteningly, in 2020, the respected US-based think-tank, Freedom House, ranked the quality of US democracy 33rd in the world among countries larger than 1m people, between Slovakia and Argentina. Given Mr Trump’s record, that is hardly surprising. 

Moreover, this was before his attempt to throw the electoral system, the core of democracy, into disrepute, with unsupported allegations of fraud.

Mr Biden’s ability to reverse all this is likely to be limited, even though he will surely wish to do so. He will surely confront obdurate resistance from Republicans in Congress, who will try to ensure that he and the federal government are seen to fail, as was their aim during Barack Obama’s presidency.

Moreover, while Mr Trump may (or may not) be gone, his marriage of plutocratic goals to nativist populism and social reaction ensures that some version of Trumpism will remain the ideology of the Republican party. This is the only viable strategy for a party devoted to low taxes and laissez faire in a diverse democracy with high inequality. 

Crucial to the success of this party is a Supreme Court dedicated to such goals, under the misleading flag of “originalism”.

It is likely then that nothing fundamental will change in US politics during a Biden presidency. Moreover, claims of a stolen election will resonate with Mr Trump’s base. 

Particularly if the GOP leadership stops Mr Biden from succeeding with the economy, the chances of a comeback for Trumpism, even Mr Trump himself, are good.

This does not mean that Mr Biden will be unable to do anything. On the contrary, the powers of the presidency are huge, abroad and (albeit less so) at home, though the Supreme Court might strip the president of some of the regulatory powers he was thought to possess. 

An immediate challenge will be Covid-19. Here, Mr Biden might be lucky. If the promise of a vaccine comes good, he might enjoy an early win.

Yet the Democrats seem unlikely to break the success of the pluto-populist strategy, partly because they are in a not-dissimilar situation themselves. They, too, depend on donations from the wealthy, who are generally unenthusiastic about higher taxes or aggressive regulation. 

The rest of the active Democratic constituency — the censorious “woke” and ethnic minorities — is likely to keep the bulk of Mr Trump’s coalition of evangelicals and non-college-educated white people united in rage.

The role of money in US politics is fundamental. A recent updating of earlier research, released by the Institute for New Economic Thinking, confirms that the views of the top decile of the population largely determine policy. The inevitable frustrations of the rest give the parties their passionate voting blocs.

A successful democracy is far more than a set of institutions. The state must be seen to serve the interests of most citizens. The latter must also share patriotism — a love of country that transcends differences of social position, political belief and economic interest. Mr Biden stands for this. Can the extremes feel the same about their opponents?

If it is unreasonable to expect any transformation in the domestic political pattern, what about the US role in the world? Here changes might be bigger. I expect a Biden presidency to attempt to revive an alliance of interests and values with the other advanced high-income democracies, notably Europe. 

I expect it will make brutally clear to the British prime minister the wisdom of friendly relations with the EU. I expect it will put the Russian president and his ideological acolytes in central and eastern Europe back in a box marked “hostile”.

I expect, too, that Mr Biden will make an effort to create an engaged, yet demanding, relationship with China in the context of realistic multilateralism. I am less sure it will be possible to manage the crucial superpower relations without serious risk of conflict. 

Somehow, the US and China must learn how to confront, compete and co-operate, at the same time. 

Particularly important will be a deal on climate. Under Mr Trump, others, notably China, have enjoyed a free ride on this issue, promising carbon chastity many decades in the future while building coal-fired power plants frantically today. But this will require the US to accelerate its own green transformation. 

The opportunity is there. But that is also likely to require some co-operation from Congress. As things are today, that looks very unlikely.

The right response to Mr Biden’s election is hope without naivety. Mr Trump has tested to destruction the idea that a solipsistic superpower determined to disrupt the global order will do much more than destroy its reputation. 

Mr Biden can do better than that, but deep conflicts will endure, at home and abroad. 

His presidency might end up as a disappointing interlude. I very much hope not. 

But his country is deeply divided and the challenges are huge.

Gold's Nuclear Winter Has Ended


Tom Bodrovics, a host of Palisades Gold Radio, welcomes returning guest John Hathaway, a Portfolio Manager of Sprott Hathaway Special Situations Strategy and Co-Portfolio Manager of the Sprott Gold Equity Fund. 

Hathaway discusses traditional portfolio weightings and why they no longer work. Bonds today are return-free risk, which opens the door for gold since something has to replace bonds. Some large pension fund advisors are considering gold as a risk mitigator. John explains how relatively small gold price moves can have an outsized impact on gold producers' profit margins. These stocks remain quite undervalued when considering their free cash flow yield.

Tom Bodrovics: Welcome to Palisades Gold Radio. I'm your host, Tom Bodrovics. Joining me today is John Hathaway. He is a Managing Director and Senior Portfolio Manager with Sprott and brings 50 years of investing experience to the table. How are you today, John?

John Hathaway: Good, thank you.

Bodrovics: John, we saw the attitude towards gold really shift around the Powell pivot, and you were speaking about this before in another interview when the Fed changed from tightening their balance sheet to re-implementing QE (Quantitative Easing) infinity. What other macro factors play a role in propelling the price of gold higher right now?

Hathaway: The biggest one, and you hear some talk about it, but not enough, in my opinion, is very low interest rates. The reason that's important is that bonds really cannot function as a portfolio risk mitigator the way they've done traditionally. [I mean] the traditional 60/40 configuration (60 percent equities, 40 percent bonds), where if stocks were going to discount a recession, interest rates would decline and that would offset the decline in equities. Bonds would rise, equities would decline.

I can't think of another time when the setup has been as compelling as it is right now for owning gold mining equities.

That doesn't work anymore because basically bonds represent return-free risk. They're basically correlated 100 percent to equities. This opens the door for gold, which has a proven history of mitigating risk. We are beginning to see some large pension fund advisors consider allocating to gold as a risk mitigator. As long as 10-year Treasury rates stay in the 1-1.5% area, something's got to replace bonds and that something is most likely gold.

Bodrovics: Excellent. I know you were talking about the sovereign negative-yielding debt being a huge risk. Can you explain why this is such a big risk and when interest rates go up, what the consequences of that could be?

Hathaway: If interest rates go up — which I don't think they will, certainly not by design — you have a world economy that is heavily levered, both private and public sector, and the bankruptcy risk, the disruption to the economy from even a 50 basis point rise on interest rates across the yield curve would slow down the economy. It would create credit risks that are sort of beneath the surface. It is tough to imagine that anybody would like to see even a small rise in interest rates. What we have talked about in our previous conversation has only become worse. The fragility of the system has increased since we last spoke.

Bodrovics: I think one thing that has exacerbated the situation and added to that fragility is the U.S. debt-to-GDP [gross domestic product] ratio. How have we seen that metric grow this year with the COVID-19 lockdowns? What are the effects and are we going to see it continue to grow?

Hathaway: Under a Biden administration, I don't think there's any secret that he's all for more stimulus, at least another couple of trillion dollars. There's no way that there's a market for it outside of what the Fed is going to do. The foreign buying has disappeared, private sector buying, maybe the banks will add to their position. The supply of U.S. debt is just too great to be absorbed outside of the Federal Reserve [the "Fed"], and therefore debt-to-GDP (we're now at 137%) could easily increase to 150% or 160% within the next couple of years.

Bodrovics: What do these factors mean for the U.S. dollar going forward? We know that there's a couple of theories out there around the consequences of these policies, and I wanted to get your thoughts on which camp you fall into.

Hathaway: I fall into the camp that the U.S. dollar is very likely to decline from here, and that's always been friendly for gold. Frankly, I would say that dollar weakness is probably the strongest pillar in the argument for gold right now.

Bodrovics: Excellent. John, on a Real Vision interview from a year ago, you made a call that the political environment was paving the way for a more radical populist, left-leaning administration, which ended up being spot on. What factors need to be taken into consideration with Biden as President?

Hathaway: To be honest, it's very constructive, although I never thought that Trump was much different. I mean, he was a populist. They're Tweedle Dee and Tweedle Dum. I assume we're going to have a Biden administration. There will be all kinds of spending initiatives. If they raise taxes, that's going to kill the economy. Certainly, at the corporate level, we have to see whether that's going to transpire. Higher taxes will hurt the economy and widen the deficit picture we've just been talking about.

Bodrovics: If they do all kinds of infrastructure spending and stuff like that, the taxes are more important and weighing on the economy heavier than any type of stimulus they would provide like that?

Hathaway: Deficit spending right now, which is basically so-called stimulus, is keeping the consumer alive. If spending is for infrastructure, who knows whether it's productive or not. But there will be a lot of money spent. If there is a silver lining in any of this, a successful virus vaccine could create some optimism and give a jolt to the economy. But I don't know if that's enough to offset deficit spending that would take place to get the economy back to pre-COVID levels. I would say it's a long shot that we get back there within the next couple of years.

Getting back to the deficit's size, the reasons for the spending, I don't think it makes much difference because we are in a period where the economy is underperforming. I think that it will last for at least another year. If that's the case, we're going to have huge deficits, a substantial debt-to-GDP ratio and ever greater fragility, and exposure to even a small rise in interest rates.

Bodrovics: John, with all these factors pointing towards the nuclear winter, as you called it, for gold being over, do we need any other fundamental tailwinds for gold to start changing the psychology and attitudes towards it?

Hathaway: We have so many things that are favorable. I would say that the big thing is that interest rates must remain low. Bonds can no longer do the job of offsetting equity risk. Large pools of capital will need to look elsewhere and that is gold. And we talked about the weaker U.S. dollar earlier.

The Fed doesn't want a strong dollar. Nobody wants a strong dollar. I'm just waiting to see further downside. Many very elite investors are calling for a 30% decline in the dollar from here. That would be dramatic and extremely bullish for gold. To me, the two strong things are interest rates have to stay low. Our fiscal situation is that we're basically in a position where we can't do anything about it and are unlikely to do anything about it. Therefore, the dollar will weaken and gold will find its way into institutional portfolios in a way that it hasn't historically.

Bodrovics: You've said in the past that physical buying of metal doesn't necessarily drive the gold price, so why does the leveraged money need to start moving into this space to really make it move?

Hathaway: I would say that it doesn't have to. Leveraged money, hedge fund money, quant money, that kind of thing, that'll come and go again if that's what you mean by leverage money. And that's really opportunity seeking capital.

The bigger story is that gold represents such a small percentage of $100 trillion of assets under management. Let's assume that there is $100 trillion of institutional money under management of all kinds, including pension funds, mutual funds, private wealth, all categories, sovereign wealth, etc. If just 1% were to move into gold over the next couple of years, that would equal $1 trillion. One trillion of demand for gold would be about six years of new mine supply. In my mind, there's no way that you could clear the market at current prices if $1 trillion were to move into the physical metal.

It doesn't take leverage; it just takes the reality of low interest rates. Capital needs a place to go to protect equity risk and gold is going to fill that vacuum. Using that math, you could easily see gold at five times the current price.

Bodrovics: Excellent, John. I'd like to talk about mining stocks. Obviously, they have been so out of favor for the last several years. I'd like you to explain to listeners who don't necessarily understand the dynamic of how a relatively small move in gold prices can massively affect the value of gold miners and how their profit margins can go up exponentially.

Hathaway: Just more basic math. It costs $1,000 an ounce to produce an ounce of gold, which is pretty much the global number. If the gold price averages, which it did last year, something like $1,500-$1,600, that means the profit margin on producing an ounce of gold was, let's call it, $500. This year, the average price of gold I will guess is likely to be about $1,800. That represents a 60% increase in the profit margin of producing an ounce of gold for the industry worldwide, and you've seen numbers that are just staggering in terms of profitability, based on reported third-quarter results. There has been a positive reaction, but to me, mining stocks are still ridiculously inexpensive. Free cash flow yields for many of the larger mining companies like Newmont, Barrick and Agnico1 are mid-to-high single digits. And there are many other mid-cap smaller companies that are producing gold that are generating free cash flow yields. That's free cash flow over a denominator of enterprise value of approximately 20%.

Unless you don't think the gold price can stay here, which I counter that it will move higher, this means incredibly positive valuation prospects for gold mining stocks. What we're seeing are dividend increases right across the board. We're seeing debt pay downs so that this industry is no longer financially leveraged. I think the industry is in very good condition financially. Mining companies are piling up cash even with all of this. The outlook is for cash generation, dividend increases and strong year-over-year earnings comparisons. You couldn't write a better scenario for an equity thesis than where gold miners are positioned right now.

Bodrovics: As we're speaking about the finances of these companies, have we seen capital become easier to get? How has it changed things in this space? Are we starting to see companies that don't necessarily deserve capital starting to pop up yet?

Hathaway: Actually, they don't need capital as they are generating so much by themselves that you're not seeing a shortage of capital. I'm sure the investment banking industry would love to do a bunch of deals, but the industry doesn't need the capital. I would say that we're in a very different place than we were ten years ago.

Bodrovics: John, what are some of the most leveraged ways, in your opinion, to speculate in this space? Would you favor M&A targets close to the top of that list?

Hathaway: There have been a lot of takeovers, but many of them have been mergers of equals, and so not at a huge premium; I can think of three or four in the last three months that were closer to being mergers of equals. There is not a lot of deal-related upside, but that could change. Right now, I don't see that taking place.

The best leverage is if you buy a large-cap company like Newmont or Barrick, and they continue to crank out all this cash flow; that's plenty of leverage because the stocks are still so undervalued. You don't have to hypothesize a big increase in free cash flow yields from, for example, 8-9% down to 2-3% to easily get doubles and triples in many mining stocks.

If you want to be more leveraged, you can go down the pecking order to mid- and smaller-cap stocks that are discounted for various reasons. But still, if you have a company that's trading at an 18-20% free cash flow yield and it goes to 10%, that's a double and it's still cheap. I don't think you need to stretch too much these days. I think you focus on quality stocks. You don't have to invest in many of the junior names — which we own and like — but they don't produce cash, at least yet. They will, in many cases, but they're riskier just because they don't produce cash.

If I were to allocate money to the space, I would own large-cap stocks and a good selection of mid- to smaller-cap companies that are actually producing.

Bodrovics: John, when you're talking about how you're valuing those larger-cap stocks, what kind of metrics are you using to really try and understand how they're undervalued at this time?

Hathaway: It comes down to what I've been talking about, cash generation and free cash flow yields. The companies can't spend the money they're generating. It's a great situation to be in. I mean, I could give you other things. You could look at price-to-net asset value. You could look at price-earnings ratios, very traditional things, price-to-cash flow, enterprise value (EV) to EBITDA.2 But I mean, one thing that we talked about recently is that EV to EBITDA for the industry generally is around 8x, which is not bad. Compare that to the S&P 500,3 it's about 18x. Again, you could just look at a straightforward metric like EV to EBITDA. The gold mining group is half as expensive as the standard variety component of the S&P 500 (see Figure 7, Gold, the Simple Math).

Bodrovics: Perfect. When we're looking at the smaller- and middle-tier companies, I'd like to get your thoughts about a single asset company and the reasons the market might possibly discount those.

Hathaway: Typically, that's because those companies would be located in jurisdictions where there's significant headline risk. I'll give you a name, just as an example. You take something like Torex [Gold Resources]1, which we like and own. They are located in a part of Mexico that's had some social license issues. Torex does a great job of this, but they're still hurt by the headline risk of being located there. If Torex were part of a larger company like Newmont or Agnico Eagle, that headline risk would go away.

In my mind, the single asset discount, which is real and it's not just for Mexico, you could talk about companies that are located in Canada. Another name that comes to mind is Pretium Resources.1 There's always a magnification of every little glitch for a single asset company that you don't get with an Agnico, Barrick or Newmont.

Bodrovics: John, are there any other assets that you're looking at besides gold and silver that make for a very asymmetrical bet right now?

Hathaway: The answer is no. I'd like to sound more open minded about it, but the setup for gold is so incredible. It's the best I've seen it in my 20 plus years of gold investing, if you think that the thesis on gold is correct and that the price moves higher over the next 3-5 years given that interest rates can't go up, the dollar is going to weaken. You don't have to talk about inflation or end of the world stuff to get excited about the gold space. I can't think of another time in the gold space when the setup has been as compelling as it is right now for owning gold mining equities.

Bodrovics: It is not a bad thing to be focused on one thing. I'd like to get your thoughts, John, on why you don't think that Bitcoin is a threat to gold.

Hathaway: People who like Bitcoin, people who like gold, are coming from the same place. They don't trust central banking; they don't trust paper currency. I just feel like it's like a losing proposition to get into a battle with people who like Bitcoin and simply say gold is better, or for them to say Bitcoin is better than gold. I just don't see the point of chasing your tail about that. I think they both have merit. I saw where Stan Druckenmiller just came out and gave a thumbs up to Bitcoin. I can see Bitcoin doing well. Not for everybody. It's more for people who are millennials, tech-oriented, Silicon Valley, etc. But it's not going to displace gold. It's much smaller.

Gold has a four-thousand-year history of protecting capital. Bitcoin is new. It may also protect capital and may have a lot to recommend it. But again, I just shy away from getting too caught up in the gold versus Bitcoin argument.

Bodrovics: Is there anything that we haven't touched on that you think is very important for our audience of gold investors, gold bugs to understand?

Hathaway: Gold is so under owned and it's still hated. It's not mainstream. You're fighting city hall. Nobody wants to get on board with it. It represents career risk for somebody in a straightforward investment firm, so it is considered a fringe investment strategy. From time to time, it's going to get knocked down a peg or two as we saw recently with the announcement that Pfizer has come up with a vaccine, which is great. I mean, who doesn't want a vaccine? So the quants just jumped all over that because it's a pairs trade.4

Time will tell. But to me, the possibility of a COVID vaccine does not change anything of what we've talked about in terms of low-interest rates, negative-interest rates, a weaker U.S. dollar, the fiscal picture being dire for the U.S. and other Western democracies. Just remember that gold, for a long time, has been considered a fringe strategy that is in some ways unfriendly to the orthodox thinking of mainstream investors.

For those of us who are supportive of gold, you're going to be fighting city hall all the way from $800 to $5,000. And I don't mind doing that. I've been doing it for a long time. But just remember that you won't get a lot of agreement from the consensus on the opportunities that gold represents.

Bodrovics: Excellent. In doing research for today's discussion with you, I came across you saying something about basically identifying your time and your ability to write your newsletter relative to where we are in the gold market. Are you still able to write it, or are you too busy to be able to do it right now?

Hathaway: No, I'm never too busy to spout off. I try to write four times a year, maybe more if necessary. I am basically trying to explain it and convey the investment rationale for investing in gold. You know others do it very well, but I think it just goes with the turf. You have to explain yourself all the time because gold is such an out-of-favor investment idea.

Bodrovics: Is there somewhere that our listeners can be able to read that?

Hathaway: Sure, all you have to do is go to the Sprott website, which includes everything I have said recently.

Bodrovics: Excellent. We really appreciate your time today, John, and look forward to reading your newsletter. Thank you very much.

Hathaway: Tom, thank you.

1 John Hathaway is Senior Portfolio Manager of Sprott Gold Equity Fund (SGDLX). In this podcast, he mentions gold mining companies Newmont, Agnico Eagle, Barrick Gold, Torex Gold Resources and Pretium Resources. As of 9/30/2020, these companies represented 2.58%, 1.28%, 3.17%, 2.73% and 1.36%, respectively, of the total net assets of Sprott Gold Equity Fund (SGDLX). Portfolio holdings are subject to change and should not be considered a recommendation to buy or sell individual securities. 

2 The EV/EBITDA ratio is a popular metric used as a valuation tool to compare the value of a company, debt included, to the company's cash earnings less non-cash expenses.

3 The S&P 500 Index is an index of stocks issued by the 500 largest U.S. companies. You cannot invest directly in an index.

4 A pairs trade or pair trading is a market neutral trading strategy enabling traders to profit from virtually any market conditions: uptrend, downtrend, or sideways movement.

Peru joins select group of nations selling century bonds

Investors offered sovereign debt maturing in 2120 even as political crisis roils nation

Colby Smith in New York and Gideon Long in Bogotá

Peru has had three presidents in a fortnight © AP

Peru has joined a select group of countries issuing debt that matures in 100 years, as investors looked past the acute political crisis that has engulfed the country in recent weeks.

The South American nation on Monday launched the sale of $1bn of century bonds, said a person familiar with the matter, in addition to $2bn of notes set to mature in 2060 and another $1bn of 12-year bonds. 

The sale comes after one of the most turbulent fortnights in Peru’s political history.

The country has had three presidents in that time: Martín Vizcarra was forced to quit after being impeached by congress and Manuel Merino, who stepped up from being head of congress, lasted just five days before huge street protests forced him to step aside. 

Francisco Sagasti, a 76-year-old former World Bank official, has since been sworn in as the country’s interim leader with a mandate to guide it through to fresh elections due in the second quarter of 2021.

“The political backdrop is challenging,” said Alberto Ramos, chief economist for Latin America at Goldman Sachs. “On the other hand, we are living in a world with abundant liquidity.”

“We think that Peru is a solid investment-grade credit despite the political volatility,” said Shamaila Khan, head of emerging market debt strategies at AllianceBernstein. “The country has a strong external position and low level of indebtedness.”

Austria, Mexico and Argentina are among other countries to have issued century bonds in the past, with Buenos Aires forced to restructure its debts earlier this year. 

Peru has been one of Latin America’s fastest-growing economies this century. Its GDP has more than quadrupled since 2000, spurred by Chinese demand for its copper. The mini-boom, helped by the successful quashing of a Marxist insurgency in the 1990s, lifted millions out of poverty and greatly expanded the middle class.

But the coronavirus pandemic cruelly exposed the deficiencies of Peru’s economic model, reminding Peruvians that too many citizens had been left behind, unable to access opportunities reserved for the more privileged in society. 

The recent political turmoil has weighed heavily on the country’s assets. The price of a dollar bond set to mature in 2050 has slipped from 163 cents on the dollar at the start of the month to 158 cents. Its currency, the sol, has also suffered, hovering near a record low last week before strengthening slightly. 

Despite the chaos, Peru was able to price the century bond at 1.70 percentage points above US Treasuries, said the person familiar with the sale. The benchmark 10-year US Treasury bond currently yields 0.85 per cent. 

Mr Ramos warned a continuation of the political volatility could prove costly for investors. “It generates volatility in asset prices and adds uncertainty to the outlook,” he said. “It could eventually down the road compromise what are now relatively solid fundamentals.”

Switzerland Is Choosing Austerity Over Life

Why Switzerland became one of the world's worst coronavirus hotspots.

Joseph de Weck 

A pedestrian looks at an illuminated map board in the empty streets of the Alpine resort of Zermatt, with the Matterhorn mountain amid the spread of the COVID-19 caused by the novel coronavirus. VALENTIN FLAURAUD/AFP VIA GETTY IMAGES

Switzerland has overtaken Belgium and is on pace to surpass Czech Republic as Europe’s top COVID-19 hot spot. Infections are roughly triple the per capita count in Sweden or the United States and double the European Union average. And this is not due to extensive testing. 

Switzerland is on par with the United States and average in Europe with regard to test prevalence. The country’s test-positivity rate stands at a whopping 27.9 percent, compared with 8.5 percent in Sweden and 8.3 percent in the United States. According to the World Health Organization, a test-positivity rate above 5 percent signals the virus is out of control.

The group of scientific experts advising the Swiss government on the pandemic has been sounding the alarm bell for a while. Hospitals are projected to run out of ICU capacity by Nov. 13. The challenge now is to keep the period of rationing of intensive health care as short as possible, the expert group says.

In normal times, the world’s celebrities and politicians, such as former Italian Prime Minister Silvio Berlusconi, travel to Switzerland to get treated in the country’s first-class hospitals. Now, France is offering to take on Swiss COVID-19 patients to give the country’s hospitals some breathing space.

What went amiss in the Alpine country widely famous for its spotless streets and widely recognized for its safety, reliability, and good governance? In one sense, the answer is simple: The Swiss government has resisted taking the necessary restrictive measures to contain the virus. 

The reasons for that resistance, however, are rather more complicated because the Swiss have long cloaked the ideological motives informing public policy in purely pragmatic language.

Like Germany, Switzerland emerged relatively unscathed from the first wave in the spring. A carefully calibrated national lockdown helped contain the virus. But contrary to Berlin, Bern did not view the success in spring as an encouragement to continue pursuing a cautious course.

Instead, the low first-wave death toll seemed to confirm the widely held perception of Switzerland as a “special case”—a unique country divorced from the world’s woes. In the last century, Switzerland never lived through a war or a major natural catastrophe. 

In this century, the Swiss have not experienced a terrorist attack, and their wallets barely suffered from the global financial crisis. The Alpine country is immune to global crisis—or so the Swiss believe is the lesson from history.

The pandemic seemed to be no different. Unlike Belgians or the French, the Swiss knew how to manage the virus—at least, that was the mood. The government marching orders to the Swiss were clear: Let’s focus on getting the economy up and running again.

After the first wave, Switzerland therefore relaxed COVID-19 measures faster and more than other European countries and the United States. Bars and clubs once again opened their doors. 

There was no obligation to wear masks indoors. The Swiss tourism promotion agency restarted its campaign on French TV. As late as Oct. 1, Bern even lifted a ban on events of more than 1,000 people. The Swiss spent the beginning of fall living as if nothing happened.

But even now, as the government acknowledges that the health situation is critical, it still hasn’t brought itself to impose a “soft lockdown” as most European governments have. Research by Oxford University’s Blavatnik School of Government shows that Switzerland’s anti-coronavirus measures are still much looser than in the rest of Europe and the United States—and only slightly more restrictive than in Sweden.

One stumbling block is federalism in an already small country. After the first wave, the federal government has given Switzerland’s 26 cantons the competence to introduce their own containment measures. But these often tiny cantons (the smallest just covers an area half the size of Manhattan) hesitate to take action. 

As a local politician, how can you explain to a restaurant owner that he has to close up shop if his colleague living five minutes away by car can still serve? And the fact that the cantons are liable for the financial costs of the COVID-19 decisions they take doesn’t help either.

But the bigger issue is that taking more restrictive measures doesn’t compute with Switzerland’s distinct small-government philosophy.

Lacking natural resources and little arable farmland due to its mountainous topography, the Swiss have traditionally recognized commerce as their only path to prosperity. The state’s constrained role in public life is also the result of the country’s creation from a quilt of formerly independent countries. 

The prime motivation for these cantons to federate was not brotherly love or building a European nation-state. It was to prevent getting swept up by one of the continent’s empires and to safeguard as much cantonal sovereignty as possible.

In Switzerland, with a weak central state and dependency on trade, business has thus been king for a long while. Since 1848, the federal government in Bern has been dominated by pro-business parties. 

There is no minimum wage and little employment protection. Fiscal federalism fuels fierce tax competition between the cantons. Government involvement in the economy is generally frowned on.

Today, the Swiss are markedly keen on personal economic initiative. Sixty-seven percent of Swiss voted against adding two weeks to the statuary holiday entitlement in 2012. The country tops the ranking for weekly work hours in Europe. 

In polls, the Swiss consistently indicate they are primarily worried about the effects of the pandemic on the economy and not the collapse of the health system. They say that even though Swiss hospitals are already postponing necessary operations, such as the removal of tumors for cancer patients, to liberate beds for incoming COVID-19 patients.

This penchant for market liberalism, fiscal conservatism, and a strong work ethic may explain the country’s resounding economic success and attractiveness to global business.

It also explains why Swiss Finance Minister Ueli Maurer says things like: “We can’t afford a second lockdown. We don’t have the money for it.” Switzerland’s debt-to-GDP ratio stood at just 41 percent in 2019. The government estimates that the loss in economic activity and support schemes in the first lockdown will mean the government will have to issue debt worth 22 billion Swiss francs (3 percent of national GDP). 

By comparison, even fiscally frugal Germany is so far set to print debt worth 6.4 percent of GDP in 2020 to finance the fight against the pandemic.

Still, Maurer claims that a new lockdown would risk sacrificing the economy and public finances on the altar of health. There is little pushback in Swiss media or politics against this view. The job of a finance minister is to keep spending in check, not to fight a pandemic, commentators write. 

Meanwhile, no political party or senior political figure has publicly pressured the government to introduce a soft lockdown.

But keeping businesses open and holding the purse strings tight may not only be bad health policy but also bad economics. 

As the fear of contagion starts to creep in, the Swiss are reducing their social life anyway, mobility data shows—leaving restaurants open but without clients. 

There is no trade-off between health and the economy, the Swiss are learning. 

Exploding case numbers have not prevented a steep rise in business insolvencies.

In this crisis, one may have to pause life and parts of the economy for a while in order to bounce back stronger and healthier later. 

In an open letter, 50 economics professors have pleaded with the Swiss government to finally introduce a soft lockdown. The government still dithers. 

Oscar Wilde observed: “To do nothing at all is the most difficult thing in the world.” 

That’s an even steeper challenge for a country that loves to work.

Joseph de Weck is a columnist with the German foreign affairs magazine Internationale Politik Quarterly and a fellow with the Foreign Policy Research Institute. 

In Mexico, the Makings of a Political Crisis

An alliance of governors underscores historical tensions in the country.

By: Allison Fedirka

A showdown is brewing in Mexico between the central government and a group of 10 state governors, known as the Federalist Alliance, who have closed ranks in recent weeks as they raise their demands for funding and reform. It’s tempting to see this as a garden variety tug of war over money, considering the economic downturn from the coronavirus pandemic. 

But in a country like Mexico, in which the relationship between the state and central governments is a long-standing existential issue, it has the makings of a political crisis.

2020 was always going to be an economically difficult year for Mexico. It was in recession even before the virus hit. The economy posted a weak performance in 2018 and contracted slightly in growth (from -0.2 to -0.6) in the last three quarters of 2019. 

Oil prices were low and production had fallen, there were restrictions on government spending, and there was a high GDP-to-debt ratio. 

The pandemic simply aggravated these problems. As the national health and ensuing economic crisis took hold, some state governors began to question the central government’s response, calling for additional funds and fiscal stimulus.

In some ways, it was a fairly typical display of the political tension endemic in Mexico. 

The push and pull between the capital and the states is rooted in the country’s mountainous and fractious geography, which makes it more difficult to project power the farther away you go from Mexico City. 

This has instilled a tradition of relative autonomy for Mexican state governors, and it explains why so many separatist movements and criminal organizations since the 19th century have been able to control not-insignificant amounts of territory there. 

President Andres Manuel Lopez Obrador understands as much, hence why he regularly meets with the governors to discuss national security and economic challenges.

However, as the pandemic threatened the health and economic well-being of the country, states were pressured to explore potential solutions of their own. They had already started fostering strategies to address security by creating local security cooperation agreements in 2018 and 2019. 

Doing the same for a health crisis seemed only natural. So in March, the states of Nuevo Leon, Coahuila and Tamaulipas formed a joint coordination group to act at the regional level. The coronavirus has never been a strictly medical issue, of course, so what started as a COVID-19 cooperation initiative has since morphed into a political force leading an organized challenge against the central government’s agenda. The group now boasts 10 members, who call themselves the Federalist Alliance.

The Federalist Alliance is seen by some as a dissident group of governors because they broke with the National Council of Governors, or Conago. Since its founding in 2000, Conago has served as the institutional framework for state governors to petition and work with the central government. 

Until the federalists left, Conago represented all 32 Mexican states. Alliance governors hail from five different political parties – shared geographies and economies are their common ground – reminding us that some of Mexico’s problems simply aren’t partisan.


In recent weeks, the Federalist Alliance has launched several initiatives meant to restructure federal funding schemes. One of its first moves was to initiate legal proceedings against the central government’s plan to extinguish 109 fideicomisos (long-term irrevocable bank trusts) worth an estimated $3.2 billion. 

This wouldn't be the first time Lopez Obrador eliminated fideicomisos; he says doing so is necessary to reduce corruption and make public funds more transparent. But the alliance objects to the government’s efforts to centralize these funds, which were previously used to finance a variety of projects involving research, health and education.

Another alliance initiative involves the fiscal pact with the federal government for the 2021 budget. (The fiscal pact is a distribution scheme for fiscal coordination between the central and state governments. The latest framework was created in 2007 by former President Felipe Calderon.) 

The governors want to make sure that states receive as much funding (or more) in real terms as they did in 2020. They also want the creation of a special fund for COVID-19 recovery efforts and economic reactivation in 2021.

The alliance understands that federal tax revenues will be slim this year, which means it understands how difficult it will be to get more money from the feds. Six members – Tamaulipas, Nuevo Leon, Jalisco, Michoacan, Aguascalientes and Guanajuato states – have gone so far as to suggest a public referendum on whether they should withdraw from the pact, a move that could upend the financial relationship between the central and state governments.

Notably, the Federalist Alliance has shown signs of longer-term objectives. Its members share a general discontent with the structure of the National System of Fiscal Coordination, which bases resource distribution by population and need. It does not take into consideration things like economic activity, potential for growth and efficient use of funds. 

They argue that this leads to a disconnect between states making large, positive contributions to economic growth, employment and tax revenue, and the receipt of federal funds. Alliance states account for 60 percent of exports by value and produce nearly 35 percent of the country’s gross domestic product, but they collectively receive only 10 percent of federal funding. They are also among the top destinations for vital foreign investment needed to spur nationwide economic growth.

The desire to restructure the broader fiscal coordination scheme also reminds us of wealth and development disparities in Mexico. Northern states are among its most developed and robust economies. 

Thanks to their proximity to the U.S. border, these states have reliable infrastructure and produce high value-added goods such as automobiles for the U.S. market. States to the south simply lag behind. 

It’s no coincidence that many of the alliance states lie in the north and are home to high-value industry and manufacturing. The restructuring they call for would very likely mean less funding for southern states.

It’s unclear how bad this budding political crisis will get. The alliance has made its agenda known and remains engaged in lobbying efforts with business, community and congressional members to gain more support for its initiatives. 

Lopez Obrador has yet to meet with the alliance but noted that the secretaries of government and finance are extensively engaged with the dissident governors. And to be clear, neither side has done anything it can’t take back. 

But it’s early yet, and Mexican history teaches us to err on the side of suspicion.

miércoles, noviembre 25, 2020


The MMT Myth

In today's environment of ultra-low interest rates and massive monetized fiscal deficits, the dangerously naive policy prescriptions offered by Modern Monetary Theory are being realized more or less by default. Whether central banks will be able to regain control after the current crisis is an open question.

Otmar Issing

FRANKFURT – Many people are now proclaiming that the COVID-19 pandemic has provided proof positive that Modern Monetary Theory (MMT) is the only way forward for governments. To the uninitiated, MMT probably sounds extremely sophisticated – even scientific. 

Its representatives speak as though they have developed a new economic paradigm comparable to the Copernican Revolution in astronomy. Yet behind the sleek title and confident policy pronouncements lies a message that is as simple as it is dangerous, particularly now that governments around the world are spending freely to keep their economies afloat during the pandemic.

According to MMT, governments can spend what they want on whatever they want until full employment is achieved, and without ever having to worry about the financing, because the central bank will provide the money by simply operating the printing press at no cost to the government. 

Whether this contribution to economic thought even deserves to be called a new “theory” is debatable, considering the unoriginality (and banality) of its central concept. Indeed, the ideas about government spending date back to the economist Abba P. Lerner’s concept of “functional finance” in the 1940s. MMT has merely tacked on a federal job guarantee.

The first publications on MMT – such as Modern Monetary Theory: A Primer on Macroeconomics for Sovereign Monetary Systems, by the economist L. Randall Wray – appeared several years ago, and were met with near-unanimous criticism from economists across the political spectrum. 

Nonetheless, the debate about MMT continues, primarily because it has been picked up by politicians like the former UK Labour Party leader Jeremy Corbyn and US Senator Bernie Sanders.

During the Democratic primaries – both in 2015-16 and 2019-20 – Sanders was advised by Stephanie Kelton, one of the best-known exponents of MMT, and the author of a new book on the topic, The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy. 

In his most recent campaign, Sanders put MMT at the center of his economic-policy program, ensuring that it would gain wider purchase on the left of the Democratic Party. Whether Joe Biden will adopt the theory’s central idea if he wins the presidency remains to be seen.

In any case, leftists around the world will remain smitten by MMT, because they are convinced that it holds the key to pursuing a long list of public projects to boost employment, protect the environment, advance social justice, and so forth. 

The proposal for a federal job guarantee promises full employment and “good” jobs that pay a living wage for work geared toward useful public purposes.

But one wonders if MMT’s adherents would still favor it if it had been embraced with similar gusto by US President Donald Trump, perhaps to pay for his promised wall on the border with Mexico. If financing government expenditures at no cost knows no limits, whoever is in power is living in the land of milk and honey. 

But this would be a temporary paradise, because a government spending spree inevitably would lead to high inflation, at which point the window of opportunity would close, and citizens would be left to pay the bill via rising unemployment and weaker real wage growth.2

Recognizing this problem, MMT proposes that the governments increase taxes when necessary in order to remove enough money from circulation to avoid inflation. Imagine that: whereas previously there had been no financial restriction whatsoever on government spending, now suddenly there are such restrictions – and taxes must be raised to claw back the excess money that had been put into circulation! It is hard to envisage an idea of democratic politics more naive than that implied by MMT.

Even if the politics did work, serious questions would remain. For example, at precisely what rate of inflation should money start to be collected through higher taxes? What happens to the already-approved public projects still in the pipeline? 

And how should policymakers account for inflation expectations, which probably will have already been priced into wages, interest rates, and numerous agreements? 

Experience shows that stopping an inflationary process once it has begun is possible only at considerable macroeconomic cost – not least in terms of rising unemployment. 

The West endured precisely this ordeal in the late 1970s and early 1980s.

To be sure, advocates of MMT are technically correct when they point out that any country able to pay its debts in its own currency cannot become insolvent, because there is no limit to the sums of money that it can create. But the idea that foreign investors would remain willing to invest in that currency under such circumstances doesn’t hold water. 

At some point, foreign capital would become effectively shut out, with serious implications for the financing of private ventures. Again, MMT claims to have accounted for this problem: in the US case, they pretend that the government cannot lose control of its interest rate.

Still, as many studies have shown, the higher the degree of central-bank independence, the lower a country’s inflation rate. That is why all leading economies saw fit to institutionalize central-bank independence in the first place (mainly in the 1990s). 

MMT, however, would revoke the central bank’s control over the printing press, and put that power in the hands of the government. As history shows, in times of emergency, the normal rules would be suspended. MMT is an approach that would create such chaos.

In today’s environment of near-zero or even negative interest rates and massive central-bank purchases of government securities, we are witnessing a move in the direction of MMT. If governments can rely on their central banks to buy unlimited amounts of government securities to prevent interest rates from rising, they have effectively already wrested control of money creation from the central bank.

In principle, an independent central bank has the power to end this process at any time, by reducing or even stopping purchases of government securities. But there would be significant political pressure weighing against such a move. Once a central bank de facto ends up in the position that MMT’s advocates seek, its ability ever to regain control becomes an open question.1

Otmar Issing, former chief economist and member of the board of the European Central Bank, is President of the Center for Financial Studies at Goethe University, Frankfurt.