How to create a durable economic recovery from Covid

Simply pumping up demand and hoping productivity growth will follow is unlikely to succeed

Chris Giles


Advanced economies are enjoying a stronger recovery than we expected a few months ago. 

This silver lining stems from an improving outlook for health, the power of government insurance which protected incomes during lockdowns and central banks facilitating cheap government borrowing. 

But it is still just a recovery. 

Not even the US has increased activity to pre-pandemic levels yet, let alone achieved the output expected before the virus struck.

Until economies sustainably exceed the levels of gross domestic product forecast before Covid-19, no one should use the phrase “build back better” as something that has been achieved. 

To succeed, advanced economies must raise the productivity of their workforces. 

Only with more efficient economies will we be able to improve wages, raise living standards and service coronavirus debts without additional strain.

But productivity has been the Achilles heel of all leading economies this century. 

In the UK, the growth rate tumbled 1.76 percentage points after 2005, from a 2.21 per cent annual average the previous decade to only 0.45 per cent. 

The US decline was almost as steep, while Japan holds the dubious honour of performing best, while still experiencing a 0.8 percentage point annual drop.

Much has been written seeking to explain this poor performance, with little resolution. 

There has been a knee-jerk willingness to blame the 2008-09 global financial crisis and few attempts to pinpoint common causes.

A new study from the Oxford Martin School seeks to resolve many of these issues with careful use of international evidence and an acceptance that there will never be a completely clean answer. 

It manages to rule out some possible causes, including a fall in the skill levels of employees, which only seems to matter in Germany, or mismeasurement of the data, which cannot explain more than a fraction of the crisis.

Instead, the authors identify causes that are significant in size and common to all countries. 

These are lower investment growth across all forms of capital — digital, machinery, transport equipment and intangibles — and the deteriorating workings of capitalism. 

Investment growth issues split roughly in two between a cyclical component caused by a lack of demand after the financial crisis and structural forces such as a shift towards intangible investment in which a slowdown of growth is more damaging to wider economic progress. 

Elsewhere, more deep-seated failures of the system have reduced competitive pressure, allowing companies to increase profit margins without the normal improvements in efficiency.

The work is helpful because it gives us a framework to judge the Covid-19 recovery policies countries are putting in place. 

Simply aiming for a “high-pressure” economy by pumping up demand and hoping productivity growth will follow is unlikely to succeed. 

This element, the paper estimates, accounts for a maximum of 0.4 percentage points of the drop, so more demand and spending must be coupled with an attempt to improve the functioning of economies, making life less comfortable for companies, intensifying competition and recommitting to globalisation.

They show that there are definitive steps countries can take to improve the lives of their citizens without having to hope that new technology produces a productivity wave they can simply ride. 

The Biden administration, for example, would score highly on improving demand and seeking to raise investment, but still falls short on its commitment to greater international competition with its Buy American trade policy.

The economics world is too often riven between those advocating strong demand and those wanting supply-side policies to bring back the dynamism of past decades. 

The truth is that both are needed and, even then, they still cannot guarantee success. 

Bitcoin: too good to miss or a bubble ready to burst?

If retail investors buy, they need to accept that cryptocurrencies come with big risks

Eva Szalay

© FT montage


The problem with investing in bitcoin is that it instinctively feels too good to be true.

The largest cryptocurrency by volume is worth 600 per cent more today than a year ago, soaring from about $7,000 per bitcoin to $54,000 this week, along the way becoming one of the best performing financial assets of 2020. 

Despite including some extreme price swings, the year-long rally has so far defied fears of a repeat of bitcoin’s spectacular price crash of 2018.

Eye-popping returns are making it difficult for even hardened cryptocurrency sceptics not to consider putting money into bitcoin and many long-term doubters are crumbling. 

Jamie Dimon, chief of US banking giant JPMorgan, is just one prominent crypto bear who turned bullish in recent years. 

Recently emerged cheerleaders include Tesla chief Elon Musk and a number of billionaire hedge fund managers who are convinced that as the digital equivalent of gold, bitcoin’s exchange rate against conventional currencies has even further to soar. 

So is bitcoin just a big Ponzi scheme or a genuine investment opportunity? 

Should retail investors give in to the temptation to pile in? 

FT Money has spoken to finance professionals inside and outside the cryptomarket and found that opinion remains sharply divided. 

The recent stellar performance has turned some bears into bulls. But hardcore naysayers warn that a bubble that has grown bigger is still a bubble.

Even ardent crypto fans are reluctant to wager their life savings on an asset associated with hair-raising levels of volatility. 

Even among these enthusiasts, many limit their investments to 1-2 per cent of their portfolio.

Regardless of whether cryptocurrencies turn out to be the digital equivalent of gold in the long run, today they are providing fraudsters with a rich hunting ground. 
Coinbase, the cryptocurrency exchange, which listed last month, was valued at $72bn © Michael Nagle/Bloomberg

Is it really different this time?

Since the start of January, bitcoin’s value has risen by 85 per cent and in mid-April it hit the latest in a series of record highs at $65,000. 

Companies that operate in the digital currency sector are attracting a flood of money. 

In a recent (conventional) stock market flotation, investors valued Coinbase, the cryptocurrency exchange launched less than 10 years ago, at $72bn, putting it equal with BNP Paribas, a French bank with roots stretching back to 1848.

Young people are in the vanguard of investing. 

In the UK, millennial and Gen Z investors are more likely to buy cryptocurrencies than equities and more than half (51 per cent) of those surveyed had traded digital currencies, research from broker Charles Schwab shows. 

After a year of spiralling prices, bears warn of the growing risk of a 2018-style collapse. 

Bitcoin bulls argue that the current rally is different from the 2018 bubble burst, when the price collapsed from above $16,000 to just $3,000. 

Today, they say, it is driven by demand from professional trading firms and institutional investors whose presence brings stability. 



Not everyone agrees. 

“It’s not different this time. 

There are no new eras, despite what the promoters tell you,” says David Rosenberg, a Canadian economist and president of Rosenberg Research. 

“Asset price bubbles come, bubbles go, but none of them correct by going sideways.”

In contrast with younger investors, those aged 55 or over remain resolutely on the margins with just 8 per cent of survey respondents in this age group trading digital currencies, the Charles Schwab study found. 

They may be right to do so. 

Investors globally have lost more than $16bn since 2012 in cryptocurrency-related scams and fraud, according to disclosure platform Xangle. 

The Financial Conduct Authority, the UK’s financial watchdog, warned this year that investors can lose 100 per cent of their money when punting on cryptocurrencies. 

It has not sought to block cryptocurrency dealings but has forbidden the sale of derivatives on crypto assets to UK retail customers.

As crypto markets are unregulated, investors have no one to turn to for help if they fall victim to fraud. 

Exchanges can turn out to be bogus and their founders disappear. 

A new coin might turn out to be a tissue of lies. 

“There are a lot of scams and criminal operations that target individuals and it’s very important to recognise that in an unregulated market there is no recourse,” says Ian Taylor, the chief executive of lobby group CryptoUK. 

Another concern for investors is the environmental footprint of cryptocurrencies. 

The carbon emissions associated with bitcoin equal that of Greece, according to research by Bank of America, because the coins are created or “mined”, in vast computing centres, which burn electricity and generate heat.

What are the ground rules?

Crypto specialists say the most important rule for investors is to be prepared to lose all their money.

On April 13, bitcoin began a sharp decline, its exchange rate shedding 23 per cent in less than two weeks. 

Marcus Swanepoel, chief executive of Luno, a retail-focused cryptocurrency exchange with 5m-plus customers, says that in some cases they were overstretching themselves. 

Luno surveyed its clients last year and found that 55 per cent had no other investments. 

“Never spend more money than you can afford to lose,” he says. 

“It’s very risky, there is no doubt about it.”

Extreme swings in the exchange rate mean cryptocurrency exposure should be kept at a low proportion of a portfolio, say most mainstream investment analysts.

“I understand if you want to buy it because you believe the price will go up but make sure it’s a very small portion of your portfolio, maybe 1 or 2 per cent,” says Thanos Papasavvas, founder of research group ABP Invest, who has a 20-year background in asset management.

Borrowing money to pump up trades with leverage amplifies gains but inflates losses. As there are no official rules, trading platforms allow investors to wager multiples of the money they deposit, inflating the amount at stake by as much as a 100 times. 

“Leverage on a crazy asset class is a recipe for disaster,” says Abhishek Sachdev, a derivatives expert and head of Vedanta Hedging.

Choosing the right coin is also important. 

There are hundreds of cryptocurrencies; most are worthless and some are plain scams. 

Bitcoin is the oldest, most liquid, coin and it is the one that enjoys support due to institutions investing due to its limited supply.

According to its original computer-based design, only 21m bitcoins will ever exist and 99 per cent of these coins will be mined by 2030. 

Other cryptocurrencies are not limited in this way and the hundreds of available digital coins all have different characteristics.

It is also the most expensive per unit but since it can be bought in small increments, there is no requirement to splash out $50,000 or so for a full coin. 

Ethereum is the second most traded cryptocurrency and has benefited from the tailwind of bitcoin’s rally. 

The technology behind ethereum is also used in a nascent market dubbed decentralised finance, making the coin a relatively safe choice. dogecoin and the likes occupy the riskiest and most illiquid end of the spectrum.

The ‘mining’ of cryptocurrencies in vast data centres has raised concerns about carbon emissions © Lars Hagberg/AFP/Getty Images


How do I buy cryptocurrencies and what are the risks?

In the UK the easiest way to access cryptocurrencies is to buy a portion of bitcoin on an established exchange such as Coinbase. 

Given that exchanges have suffered outages, been hacked or collapsed, this is the safest approach, though it is more expensive than other exchanges.

Coinbase typically charges a spread of about 0.50 per cent plus a fee depending on the size of purchase and payment method.

Fintech companies such as Revolut also offer a way in for bitcoin buyers, but there is no way to transfer bitcoins from the app elsewhere or into other types of coin. 

Since they may only sell it back within Revolut, investors only nominally own bitcoin via the app. 

In the US, investors are able to buy shares in diversified cryptocurrency funds such as Grayscale, which can then be bought and sold like other mutual holdings. 

Institutional investors can also buy into exchange traded products but these are inaccessible for retail investors in the UK. 

It is possible to buy into products that offer exposure to companies active around blockchain — the public, digital ledger than underlies bitcoin — such as Invesco Elwood Global Blockchain UCITS ETF. These are a bet on technology, however, rather than the cryptocurrency. 

Selling cryptocurrencies also has tax implications. 

Digital assets count as property for accounting purposes and profits may be subject to capital gains tax.

Scammers are a growing problem. 

Some ask investors to send their private keys to their crypto holdings, promising to return with a profit. But once done, there is no way to undo a transfer.

Lihan Lee, co-founder of Xangle, advises potential investors to check the past records of any crypto investment schemes, while CryptoUK’s Taylor warns of posting about cryptocurrency investment on social media or cold callers promising guaranteed returns. 

“If a stranger walks up to you on the street and says they’ll give you £150 if they can borrow £100, you probably wouldn’t give them the money,” he says. 

“It’s the same with crypto.” 

Why are institutions getting involved?

“If it’s on the side of a bus it’s time to buy,” screams an advertisement from Luno in London. 

Many seasoned investors say the ad should say the opposite. 

If everyone is talking about the same thing, it’s a sure-fire sign that prices have reached unsustainable heights and are about to collapse — as they did in 2018. 

But in the past 12 months companies and institutional investors have cautiously dipped their toes into digital assets. 

Since central banks around the world responded to the coronavirus pandemic with easy money policies, large asset managers and hedge funds have been looking for ways to protect themselves from a return of inflation and the erosion in value of of some currencies, including the dollar.

“We’ve seen a step change in institutional interest last year,” says James Butterfill, an investment analyst at digital asset specialist Coinshares. 

He notes that around $54bn of money is invested across 120 cryptocurrency funds. 

A year ago, the total figure was $3.5bn across 89 funds. 

“Cryptocurrencies are here to stay,” wrote Christian Nolting, global chief investment officer at Deutsche Bank’s international private bank, in a report. 

Central banks are even exploring the idea of issuing digital alternatives for domestic currencies. 

To some analysts, central bank digital currencies lend legitimacy to the crypto space, while others believe it is an attempt by central banks to wrest back control of the market.

“Central banks have always thought that they were key for payments,” says Randy Kroszner, professor of economics at the University of Chicago Booth School of Business. “And now they’ve realised they’re not.”

But that does not mean that the risks of cryptocurrencies are likely to dissipate any time soon. As the unregulated market bounces through its latest price gyrations, it is a long way off from either stability or security.

‘Crypto is by far my most profitable investment’

“Money and IT are my core things,” says Adrian, a financial services professional in his late 40s, who asked the FT not to use his full name to avoid “tax complications”. 

In many ways, he is the archetypal cryptocurrency investor in the current bitcoin rally. 

Following his divorce, a pub conversation in 2017 led him to look into cryptocurrencies. 

Since then, Adrian has gone deep.

“I have property, wine, lots of different investments but crypto is by far the most profitable. 

I look at what I put in and there is no better return anywhere else,” he says.

He says he owns about 50 different types of cryptocurrency but has kept as much as 70 per cent of his investment in bitcoin, which he regards as the safest and most liquid option. 

He is also actively trading — hence his concerns about HM Revenue & Customs — on various exchanges and in the fledgling derivatives market, using leverage to amplify the outcome of his bets.

Venturing beyond buying and holding coins, Adrian has entered the rapidly growing area of decentralised finance, which uses the “digital ledger” technology of blockchain to replace intermediaries in trading, lending and borrowing. 

One crypto insider describes decentralised finance — also known as “DeFi trading” — as the world’s most adversarial market. 

“You can make anything between 100 and 1,000 per cent, but it’s probably not for beginner investors,” he says, adding that trading in this area requires a heavy commitment in time and research.

Adrian says he will “never” sell his bitcoins but aspires to borrow against his holdings in DeFi markets to buy a home in a couple of years. 

Having gone from bitcoin novice to evangelist in three years, he believes blockchain has the potential to replace insurance companies, retail banks and central banks.

“If you’re selling bitcoin you’re going long fiat. 

Why would you ever want to do that?” 

      Abhishek Sachdev, head of Vedanta Hedging


Sachdev has taken a much more moderate approach. 

The derivatives expert runs financial advisory firm Vedanta Hedging and takes a dim view of overly complex products. 

He nonetheless started “dabbling” in bitcoin in January this year. 

“I can give you 20 reasons why investing in bitcoin is a good idea and 20 reasons why it’s a crap idea,” he says, noting that he took the plunge after two people whose views he respects encouraged him to do so. 

“I did some research and downloaded CoinbasePro.”

His initial investment of about £20,000 has so far yielded a profit of roughly 35 per cent. 

Still, given bitcoin’s volatility he is taking a cautious approach and says he would never use leverage. 

Sachdev still owns more gold than bitcoin but says this could soon change. 

“I don’t want to invest any more into crypto than 5 per cent of my equity investments,” he says. 

“Returns are bigger and quicker than in other alternative markets like art or wine, but it’s a lot more frothy and prone to bubbles because it’s very new.” 

He would “ride out” any collapse in price, he says, and has had no issues when converting some of his bitcoin into fiat currency. 

But he also believes bitcoin’s success might be too big for central banks to ignore. 

Bitcoin’s failure thus far to fulfil its promise of becoming a mundane, ubiquitous means of payment does not worry him, however.

“I’m not too bothered about not being able to use it in Sainsbury’s. 

I see bitcoin as an uncorrelated asset. 

Just because it can’t do everything it doesn’t mean it doesn’t have a place.”

How will Latin America’s covid-19 bill be paid?

Colombia is a test case of the difficult fiscal decisions governments will face


The timing could hardly be more awkward. 

Colombia is suffering a third peak of covid-19, even more deadly than its predecessors. 

Almost all intensive-care beds in the main cities are full, and oxygen tanks are running short. 

Bogotá, the capital, is under a red alert, with the working week cut to four days and a curfew at 8pm. 

Yet in April the government of President Iván Duque sent a bill to Congress proposing stiff tax rises. 

Although the increases would be phased in, the government thinks it must signal now its intention to raise more revenue, particularly if it is to provide emergency aid to its people until the pandemic is over. 

Many of the country’s politicians disagree, and the bill was the target of a large national protest on April 28th.

Colombia is an early example of the fiscal dilemmas Latin American governments will soon face. 

The region has suffered grievously in the pandemic. 

Its economy shrank by 7% last year, more than double the average contraction around the world. 

As lockdowns eased a couple of months ago, there was optimism that recovery might exceed the 5% growth of most forecasts. 

But then the p.1 variant of the virus, first detected in Brazil, began to run wild. 

Like Colombia, other South American countries have been forced to restrict movement yet again. 

Meanwhile vaccination is happening slowly. 

The result is that 2021 is shaping up to be another difficult year.

Matters would be even worse had governments not been able to soften the blow with aid to poorer households and to firms. 

Though not on the generous scale of many rich countries, this fiscal stimulus was much more than the region managed in past slumps. 

According to a study by the imf, it averaged about 4.5% of gdp. 

With revenues falling because of the recession, fiscal deficits ballooned and public debt rose last year from an average of 64% of gdp to 72%.

That would once have been seen as a dangerously high figure. 

But low international interest rates make it more affordable. 

Nonetheless, several governments are scaling back aid even as the pandemic continues. 

Many economists think that is a mistake. 

Investors will tolerate deficits and debts provided governments set out—and preferably approve—credible measures to curb them once economies have recovered.

“It’s right to spend during the pandemic,” argues Alejandro Werner, the imf’s outgoing director for Latin America. 

“But it’s also right to start thinking about tax and spending reforms.” 

In a typical Latin American country, paying for the better health care and social assistance citizens are demanding while at the same time servicing higher debt requires a rise in government revenue of between 1.5% and 3% of gdp. (Some countries would need instead to trim ineffective spending.) 

If recovery turns out to be slower, tax rises could be postponed.

This is the path Colombia’s government wants to follow. 

Its bill raises around 2% of gdp in additional revenue, mainly by widening the net of income tax and removing exemptions in vat. 

Mr Duque says that would allow the government to continue to make emergency payments of $44 per month to over 3m poorer households, compensate them for levying vat on basic goods and continue a furlough scheme. 

It would also safeguard Colombia’s investment-grade credit rating, which makes borrowing cheaper for firms and the government.

The bill is praised by tax specialists but, with a general election due next year, it has prompted political uproar. 

Woundingly for Mr Duque the critics include Álvaro Uribe, a conservative former president who is his political sponsor. 

Mr Uribe has submitted an alternative bill that would cut the revenue gains in half.

Other countries will soon face similar decisions. 

The region is not facing a debt crisis—or at least not yet. 

But the credit-rating agencies are flashing an amber light.

Joydeep Mukherji of Standard & Poor’s, one agency, notes that with 13 downgrades since the pandemic began and nine “negative outlooks”, 

Latin America’s credit score has been hit harder than that of any other region.

If Colombia’s tax reform is thwarted by short-term political considerations, that sends the wrong message to other governments. 

The risk is that “we’ll end up with not enough stimulus and problems with the financial markets,” says Mauricio Cárdenas, a former finance minister in Colombia. 

That would mean Latin America would have to say adiós to a robust economic recovery.

The Ghost of Arthur Burns

The US Federal Reserve is insisting that recent increases in the price of food, construction materials, used cars, personal health products, gasoline, and appliances reflect transitory factors that will quickly fade with post-pandemic normalization. But what if they are a harbinger, not a "noisy" deviation?

Stephen S. Roach


NEW HAVEN – Memories can be tricky. 

I have long been haunted by the inflation of the 1970s. 

Fifty years ago, when I had just started my career as a professional economist at the Federal Reserve, I was witness to the birth of the Great Inflation as a Fed insider. 

That left me with the recurring nightmares of a financial post-traumatic stress disorder. 

The bad dreams are back.

They center on the Fed’s legendary chairman at the time, Arthur F. Burns, who brought a unique perspective to the US central bank as an expert on the business cycle. 

In 1946, he co-authored the definitive treatise on the seemingly rhythmic ups and downs of the US economy back to the mid-nineteenth century. 

Working for him was intimidating, especially for someone in my position. 

I had been tasked with formal weekly briefings on the very subjects Burns knew best. 

He used that knowledge to poke holes in staff presentations. 

I found quickly that you couldn’t tell him anything.

Yet Burns, who ruled the Fed with an iron fist, lacked an analytical framework to assess the interplay between the real economy and inflation, and how that relationship was connected to monetary policy. 

As a data junkie, he was prone to segment the problems he faced as a policymaker, especially the emergence of what would soon become the Great Inflation. 

Like business cycles, he believed price trends were heavily influenced by idiosyncratic, or exogenous, factors – “noise” that had nothing to do with monetary policy.

This was a blunder of epic proportions. 

When US oil prices quadrupled following the OPEC oil embargo in the aftermath of the 1973 Yom Kippur War, Burns argued that, since this had nothing to do with monetary policy, the Fed should exclude oil and energy-related products (such as home heating oil and electricity) from the consumer price index. 

The staff protested, arguing that it made no sense to ignore such important items, especially because they had a weight of over 11% in the CPI. 

Burns was adamant: If we on the staff wouldn’t perform the calculation, he would have it done by “someone in New York” – an allusion to his prior affiliations at Columbia University and the National Bureau of Economic Research.

Then came surging food prices, which Burns surmised in 1973 were traceable to unusual weather – specifically, an El Niño event that had decimated Peruvian anchovies in 1972. 

He insisted that this was the source of rising fertilizer and feedstock prices, in turn driving up beef, poultry, and pork prices. 

Like good soldiers, we gulped and followed his order to take food – which had a weight of 25% – out of the CPI.

We didn’t know it at the time, but we had just created the first version of what is now fondly known as the core inflation rate – that purified portion of the CPI that purportedly is free of the volatile “special factors” of food and energy, where gyrations were traceable to distant wars and weather. 

Burns was pleased. 

Monetary policy needed to focus on more stable underlying inflation trends, he argued, and we had provided him with the perfect tool to sharpen his focus.

It was a fair point – to a point; unfortunately, Burns didn’t stop there. 

Over the next few years, he periodically uncovered similar idiosyncratic developments affecting the prices of mobile homes, used cars, children’s toys, even women’s jewelry (gold mania, he dubbed it); he also raised questions about homeownership costs, which accounted for another 16% of the CPI. Take them all out, he insisted!

By the time Burns was done, only about 35% of the CPI was left – and it was rising at a double-digit rate! 

Only at that point, in 1975, did Burns concede – far too late – that the United States had an inflation problem. 

The painful lesson: ignore so-called transitory factors at great peril.

Fast-forward to today. 

Evoking an eerie sense of déjà vu, the Fed is insisting that recent increases in the prices of food, construction materials, used cars, personal health products, gasoline, car rentals, and appliances reflect transitory factors that will quickly fade with post-pandemic normalization. 

Scattered labor shortages and surging home prices are supposedly also transitory. 

Sound familiar?

There are many more lessons from the 1970s that shed light on today’s cavalier dismissal of inflation risk. 

When the Fed finally tried to tackle the Great Inflation, it fixated on unit labor costs – rising wages accompanied by sagging productivity. 

While there are always good reasons to worry about productivity, wages appear to be largely in check; unionized labor, which, in the 1970s had sparked a vicious wage-price spiral through cost-of-living indexation, has been neutralized by global competition. 

But that doesn’t rule out a very different form of global cost-push inflation – namely, the confluence of supply-chain congestion (think semiconductors) and protectionist clamoring to reshore production.

But the biggest parallel may be another policy blunder. 

The Fed poured fuel on the Great Inflation by allowing real interest rates to plunge into negative territory in the 1970s. 

Today, the federal funds rate is currently more than 2.5 percentage points below the inflation rate. 

Now, add open-ended quantitative easing – some $120 billion per month injected into frothy financial markets – and the largest fiscal stimulus in post-World War II history. 

All of this is occurring precisely when a post-pandemic boom is absorbing slack capacity at an unprecedented rate. 

This policy gambit is in a league of its own.

For my money, today’s Fed waxes far too confidently about well-anchored inflation expectations. 

It also preaches the new gospel of “average inflation targeting,” convinced that it can condone above-target inflation for an unspecified period to compensate for years of coming in below target. 

My students would love to throw out their worst grade(s) as well!

No, this isn’t the 1970s, but there are haunting similarities that bear watching. 

Timothy Leary, one of the more memorable gurus of the Age of Aquarius, purportedly said, “If you remember the 1960s, you weren’t there.” 

That doesn’t apply to the 1970s. 

Sleepless nights and vivid flashbacks, complete with visions of a pipe-smoking Burns – it’s almost like being there again, but without the great music.


Stephen S. Roach, a faculty member at Yale University and former chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China.

Unhedged: Stock prices and the velocity of money

Also bitcoin replies and housing prices

Robert Armstrong


QE and stock prices (part two)

Here are two lines that mostly go up and to the right:


The two lines are the M2 money supply (cash, deposits, money market accounts) and the S&P 500. 

M2 is rising fast because of quantitative easing: the Fed is buying securities for cash, thereby putting new money out there. 

Why the S&P is rising fast is less clear. 

The fact that the two lines have moved together lately encourages a popular causal story: “the Fed is printing money, and it has to go somewhere, and it is going into the stock market.” 

A couple of days ago I noted that these causal stories are wrong, because cash is not transformed into stock. 

When I buy shares, the seller gets the cash. 

It is not “in the stock market”. 

What is really happening is that all the additional money sloshing around makes people want it less, relative to stocks, and the increased relative demand for the stocks forces share prices up.

That’s how QE affects stock prices (or one way it does; other people, especially central bankers, prefer stories about QE lowering the discount rate, on which more shortly.)

Eric Barthalon, global head of capital markets research for Allianz Research, notes that this process is self-limiting. 

As equity prices rise, the weight of cash relative to equities in investors’ portfolios goes down to a level where the investors are happy. 

Investors stop trading so much, and prices stabilise. In this story, it’s not the Fed simply stuffing the markets with cash. 

There is an intermediary factor: investors’ relative preference for cash. 

Barthalon’s argument — I find it pretty convincing — is that (a) investors preference for cash is not stable and (b) the Fed is not in control of it at the moments that matter, that is, when markets are falling. 

You can track investors’ unstable preference for cash by looking at the velocity of money, or how much it changes hands. 

Barthalon told me:

“It is not the quantity of money but its circulation that causes asset prices to rise or fall . . . and historical experience shows us that central banks do not control the velocity of money, especially in capital markets.”

Now we see why central bankers might prefer the notion that with QE, they control the discount rate that determines the value of stocks, by keeping yields on government bonds low. 

Because that lever will, in theory, work even if investors suddenly decide they like cash quite a lot — which they do when markets fall.

Here is Barthalon’s long-term chart of the velocity of money in the stock market (the value of daily market transactions divided by M2) against the value of the stock market. 

Look at how velocity drops hard in market declines:


Those two lines co-vary, and are related by a tidy causal story. 

The takeaway is that the sheer volume of money floating around can’t, by itself, keep the stock market high. 

Dept of Armstrong is wrong: bitcoin

Yesterday I argued that bitcoin is best thought of as equity in a company whose only asset is an unproven technology. 

That technology will be proven when bitcoin becomes money. 

But bitcoin is not money now because, while people trade it, it is not widely accepted as a form of payment, there are few transactions in it, transaction costs are high, and so on.

The most common reply I received was that bitcoin is not trying to be money. 

Money has two key properties. 

It is a store of value and a medium of exchange. 

Most of the people who think I am wrong think bitcoin is all about storing value. 

That is why its finite supply is so important. 

If it’s a bit costly to trade, a bit illiquid, and so on — who cares. 

It is akin to gold and diamonds, commodities whose salient feature is their rarity and how much they are prized, not their ease of use.

I am not convinced. 

Gold and diamonds have uses in industry and jewellery, they have millennia of convention supporting their preciousness. 

The only thing supporting bitcoin as a store of value, as a precious commodity, is that it might be both a store of value and an especially good medium of exchange — one that can transact widely, frictionlessly, at a low cost, and (here is the real key) without third-party oversight or government control. 

And I don’t think we yet know that this is so. 

Bitcoin is scarce, but so are the watercolours I painted in high school. 

That does not make them a store of value.

One good read

I was struck by this Bloomberg story about how house demand in the US is so strong that homebuilders are moving away from fixed prices, doing blind auctions to secure the highest possible bids:

“A collision of pandemic-related forces [is] holding back new inventory just when it’s needed most. 

Buyers are stampeding for new homes as remote work upends employment, while soaring lumber costs and a shortage of workers are slowing construction.”

This description suggests there is no toxic 2007-style speculation in the mix. 

That makes me paranoid. 

Isn’t speculation everywhere these days? 

Why not housing? I don’t know if there is any evidence that there is, but I’m going looking. 

If you have any, email me.

Present at the Republican Self-Destruction

While former Republican Speaker of the House John Boehner's recent memoir offers a tale of woe for his party, a new biography of Nancy Reagan shows just how far the institution has fallen. The big question now is whether the GOP will be able to reclaim respectability before it meets with complete ruin.

Elizabeth Drew


WASHINGTON, DC – Two books recently appeared that shed light on highly important aspects of US politics. 

Both offer views of the Republican Party’s decline from relative unity under Ronald Reagan – first as reflected in Karen Tumulty’s astonishing biography of Nancy Reagan; and then as portrayed by a recent Republican Speaker of the House, John Boehner.

Boehner’s departure from politics in 2015 can be seen as an omen of what was about to become of his party. 

Caught between traditional politics and a new wave of radicalism, House Republican leaders haven’t been lasting long. 

Boehner’s successor, Paul Ryan, gave up politics after two terms as speaker. 

The current Republican House leader, Kevin McCarthy, flounders between fear of Donald Trump’s continuing influence and pressures from the less radical members who have wanted to break loose from Trumpism.

In his memoir, Boehner tells vivid stories with more than a dash of spiciness. 

In fact, the book’s herky-jerky sections read as if he dictated them. Sometimes, he surgically alters events. 

For example, in talking of Newt Gingrich having to give up the speakership after the 1998 midterm election, he hurries over the fact that House Republicans had lost seats, for which Gingrich’s bombastic style was blamed.

Boehner leaves out altogether that another reason Gingrich had to resign as speaker (he also left Congress) was because at the same time that he was pushing Bill Clinton’s impeachment, ostensibly for lying under oath about his sexual affair with a White House intern, Gingrich was having his own affair. 

Boehner says that he opposed Clinton’s impeachment as too partisan and unserious of a matter; yet he went along with it.

Boehner’s characterizations of leading Washington figures are deadly – and dead on. Of Senate Republican leader Mitch McConnell, he says, “He’s made a living out of being inscrutable.” 

Of Ted Cruz, one of the most disliked senators by colleagues in both parties: “There is nothing more dangerous than a reckless asshole who thinks he is smarter than everyone else.”

Utilizing his selective memory, Boehner at one point criticizes the then-incoming Democratic president, Barack Obama, for not working with Republicans on a stimulus bill. 

But Boehner omits that Obama, during his first week in office, had said, in an unusual gesture, that he would come to Capitol Hill to discuss it with them. 

As Obama’s limousine was en route to the Capitol, House Republicans announced their opposition to his proposal.

The Republican party’s decline as a responsible governing instrument picked up speed during Boehner’s speakership. 

In the 2010 midterm election, Republicans attacked what they sneered at as “Obamacare.” (Obama shrewdly embraced the term). 

Obamacare was so unpopular, Boehner writes, that “You could be a total moron and get elected just by having an R next to your name.”

Boehner, catapulted into the speakership by the 2010 election, makes it clear that he felt that quite a number of the Republican members fit into that category. 

Those members, he implies, ended up forming Trump’s base, “the crazy caucus.” Boehner has little use for people with no experience in politics coming into Congress believing that they can run the place – and he has a point.

Unlike most Republican officeholders, Boehner flatly blames Trump for the January 6 insurrection. 

Trump’s lingering stranglehold on the party is demonstrated by the fact that Republicans are trying to protect him from an independent inquiry into the Capitol riot, and the fact that the great majority of Republicans still deny that Joe Biden was legitimately elected president. 

Increasingly, the few relatively moderate Republicans left in Congress are choosing to retire rather than be defeated in a primary by a Trumpian ideologue.

Boehner’s speakership represents the dividing line between a Republican party that participated in the give-and-take of politics and one that barely believes in democracy. 

Tumulty’s biography of Nancy Reagan depicts an earlier, more tranquil time. 

The Ronald Reagan she describes would probably be baffled by what has become of the party he led through two relatively successful, albeit controversial, presidential terms.

Tumulty’s book depicts the astonishing and probably unequaled role played in this success by a presidential spouse. 

Previously, it had never crossed my mind that I would ever compare Nancy Reagan to Eleanor Roosevelt. 

But despite their yawning differences, the two women had more in common than I ever imagined, at least when it came to influencing the policies of the men they married.

In Tumulty’s careful telling, Nancy Reagan understood that famously opaque man better than anyone. 

She knew when to coach him and when to leave him to his instincts, which often served him well. 

Ronald Reagan’s staff lived in fear of his wife, and dreaded her calls. 

Those who crossed her, or who she thought weren’t sufficiently attentive to her husband’s interests, didn’t last long.  

While Eleanor Roosevelt concerned herself with policy and had influence over some of her husband’s decisions, she didn’t attempt to co-reign over the White House. 

She essentially confined her activities to where she had a passionate interest of her own – mainly the plight of the working class. 

Nancy Reagan’s interest in discouraging the use of dangerous drugs (“Just Say No”) was appliqued onto her to try to provide a more serious mien, to offset her image as a frivolous clothes horse. 

The book makes clear that Nancy sacrificed a relationship with her children to the intense love affair she had with her husband. 

The book also suggests that the Alzheimer’s that Ronald Reagan died of after he left office was present in his presidency.

But Nancy Reagan’s influence on her husband did yield serious results. 

Her crowning achievement, reported by Tumulty in a riveting narrative, was to push the communist-hating Ronald Reagan into making decisions that had much to do with ending the Cold War. 

Tumulty also makes it clear, though, that Ronald himself, an “idealist,” was looking for an opening for dealing with the Soviet Union. 

These two books show us the Republican Party at its apex and at its nadir. 

The question is whether Boehner’s bitter and brutal, but not inaccurate, assessment of its current state will obtain in its future.


Elizabeth Drew is a Washington-based journalist and the author, most recently, of Washington Journal: Reporting Watergate and Richard Nixon's Downfall.