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The Economics of Populism | CFA UK Society

Page 1

Alberto Gallo, CFA

Portfolio Manager, Algebris Macro Credit Fund (UCITS), Head of Macro Strategies


Page

Source: Algebris (UK) Limited

2

1950-1970 Rise of post-war debt-based democracies

1970-2008 Leverage, de-regulation, globalisation

2008-2017 Global QE to the rescue

2017-now Financial fragility and populism

A Story of Dreams, Greed, Fear and Hope


Page 3

Debt-based Democracies

“Politicians are resourceful people. …

A smart politician can see that if somehow the consumption of middle-class householders

keeps rising, if they can afford a new car every few years and the occasional exotic

holiday, and best of all, a new house, they might pay less attention to their stagnant

monthly paychecks.

And one way to expand consumption, even while incomes stagnate, is to enhance access

to credit.”

Raghuram Rajan, Former Governor of the Reserve Bank of India, August 2010

Algebris (UK) Limited is authorised and regulated by the Financial Conduct Authority.

Page

Financial

crisis & QE

0

10

20

30

40

50

60

70

1947 1957 1967 1977 1987 1997 2007 2017

US GDP

US total credit

Europe total credit

UK total credit

China total credit

4

The Debt Supercycle: from Fiat Money to Fiat Credit

Source: Federal Reserve, European Central Bank, Bloomberg, FRED, PBoC. Private credit calculated as the sum of household loans, corporate loans and bonds and bank debt

Total Private Credit in US$ Trillion (lhs)

Bretton Woods

breaks downFreddie Mac created

Right to buy

Reserve

requirement

abolished (UK)

First Fannie

Mae MBS

Big Bang

(UK)

Glass-Steagall

Act repealed

Privatisation of Fannie Mae346%

GDP

261%

385%

283%

The EuroHelp to

Buy (UK)


Page 5

Rising Inequality

"Our results suggest that the overall effect of monetary policy on standard relative

measures of income and wealth inequality has been small“

The distributional impact of monetary policy easing in the UK between 2008 and 2014,

Bank of England, March 2018


Page 6

Rising Wealth Inequality

10

15

20

25

30

35

40

45

50

Ja

pa

n

Fra

nce

Italy

UK

Cana

da

Chin

a

Germ

any

US

Bra

zil

Wo

rld

2007 2016 2018

Share of Top 1% of Wealth Holders

Since 2007

% o

f W

ealth

Source: Algebris (UK) Limited, Credit Suisse Global Wealth Databook 2018 Source: Algebris (UK) Limited, FRED

42%

43%

44%

45%

46%

47%

48%

3%

4%

5%

6%

7%

8%

9%

10%

11%

12%

199

5

199

6

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

201

6

201

7

Corporate Profits After Tax/ GDP (LHS)

Wages and Salaries/ GDP (RHS)

Corporate Profit vs. Wages as

Percentage of GDP


Page 7

The American Dream is Broken

40%

50%

60%

70%

80%

90%

100%

1940 1945 1950 1955 1960 1965 1970 1975 1980

Source: Algebris (UK) Limited, The Equality of Opportunity Project

The Fading American DreamFraction of children earning less than their parents, by birth year


Page 8

Income Inequality – The Elephant In the Room


0

10

20

30

40

50

60

70

80

0 10 20 30 40 50 60 70 80 90 100

Cu

mu

lative

gro

wth

ra

te (

%)

Global Income Percentile

Global Growth Incidence Curve, 1988-2008Increase in real income by percentile of global income distribution

Source: Algebris (UK) Limited, The World Bank (Dec 2013)


Page 9

Corporate Inequality


0

5

10

15

20

25

30

35

40

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

90th Percentile

Median

25th Percentile

Pe

rce

nt (%

)

10

12

14

16

18

20

22

24

0

10

20

30

40

50

60

1980 1985 1990 1995 2000 2005 2010 2015

Share of Total Firms (LHS)

Share of Total Employment (RHS)

Pe

rce

nt (%

) Pe

rce

nt (%

)

Return on Invested Capital (including Goodwill)

US Publicly-traded Non-financial Firms

Young Firms as a Share of the Economy

1982 - 2015

Source: Algebris (UK) Limited, Furman J., Market Concentration , OECD (May 2018)Source: Algebris (UK) Limited, Furman J., Market Concentration , OECD (May 2018)


Page 10

Inequality and the Politics of Rage

Source: Algebris (UK) Limited, the National Association of Community Health Centers, UK Government, Bloomberg, Eurostat, ECB, World Wealth and Income Debate.*Cylus, J., Papanicolas I., An analysis of perceived access to health care in Europe: How universal is

universal coverage?, Health Policy 119 (2015), July 2015; Cobb, J., Lin, K., Gabriel, P., Growing Apart: The Changing Firm-Size Wage Effect and Its Inequality Consequences, 27 May 2016

Homeownership Education

Inequality Age

Wages/Income Wealth/Assets

Technology GlobalisationQE/Monetary Policy

Politics

Median value of owned financial

assets in Euro area: €5k for

people aged below 35 vs €18k for

55-64

- The poor are 5 times

more likely than the

wealthy to have access

barriers to health care

across Europe*

- In the US, almost a

fifth of children under

17 year live in poverty

- 3.7mn of children are

living in poverty in the

UK

Health

UK homeownership rate:

73% in 2008 vs 64% now;

35% for people aged 25-

34 vs 69% for 65-74

- 20%-33% of students at Harvard, Princeton or Yale,

had parents you attended the same college.

- 0.8% Oxbridge graduates are 75% of Senior Judges

and 38% of Lords in the UK.

The top 1% households own

20% of total personal wealth

in the UK, 22% in France

and 37% in the US

The top 1% income earners

account for 8% of total income in

France, 13% in the UK and 13% in

Germany

Automation, sharing

mean wage

polarisation

Outsourcing of

manufacturing jobs Wealth effects favouring asset

owners

Overall

unemployment

Youth

unemployment*

Spain 19% 43%

Italy 12% 40%

France 10% 26%

Germany 4% 7%

*Youth = aged below 25

Fragile Society

Corporates

An employee of a company

with > 500 employees could

typically earn 30%–50% more

than someone doing the same

at a 25-person company

http://www.healthpolicyjrnl.com/article/S0168-8510(15)00170-0/pdf

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2785868


Page 11

The Rise of Populism

“The price paid by good men for indifference to public affairs is to be ruled by evil men.”

Plato


Page 12


UK/Brexit US/Trump

1. Dream

2. Enemy

3. Policies

Results

Economic

Political

Foreign

Domestic

Militarism

Nationalism

Protectionism

Large deficits

Resource misallocation

Rising public debt

Financial Repression

(Inflation, Taxes & War)

£350mn a week Revive manufacturing

Take back control MAGA

Europe Mexico, China, NK

Immigration

Spain/Gibraltar/Russia

Wall, Buy American

Tariffs Border Adjustment Tax

Immigration

Defence spending

Tax haven

The Populist Playbook

Italy/5S & NL

Jobs

Contract with Italians

EU/ECB

UBI

Flat tax

Immigration

Police spending


Page

Source: Algebris (UK) Limited, Dornbusch, R. and Edwards, S., The Macro Economics of Populism in Latin America (1991)

13

The Populist Trap: An Economic Tragedy in Four Acts

Pre-conditions

• Inequality

• Disenfranchised regions and parts of the population

• Implosion of the political centre

• Immigration issues

1. Conviction

• High public support

• Fully vindicated in their policies

• Economic expansion without high inflation

2. Bottlenecks

• Demand expansion constrained by supply-side issues

• Rising inflation

• Worsening trade balances

• Rising public debt and deficit

3. Crisis

• Confidence waning

• Currency depreciation accelerating

• Capital flight

• Rapidly rising public debt and deficit

4. Orthodox Stabilisation

• Orthodox policies take over

• IMF programme

• Painful adjustments to stabilise


Page

Johnson

TrumpErdogan

Corbyn

MacriMacron

Haddad

AMLO

OrbánSalvini

Di Maio

Merkel

14

Populism

The Populist Playbook


Populist

Reformist

Right-Wing EconomicsLeft-Wing Economics

Maduro

Rivera

Åkesson

BolsonaroMalema


Page 15

Italy and the UK

Lamp-Wick “In the Land of Toys, every day, except Sunday, is a Saturday”

Pinocchio: “And if the Fairy scolds me?”

Lamp-Wick: “Let her scold. After she gets tired, she will stop.”

Pinocchio, Carlo Collodi, 1940


Page 16

Fragile Politics

Geographical Income and Political Polarisation

Source: FT

2018 Italian Elections: Leading Party by Region

Source: University of Oxford

2016 Brexit Referendum: Remain vs Leave


Page

Fragile Politics

17

Source: Algebris (UK) Limited, Eurostat, Italian Government Ministry of the Interior

2018 Italian Elections: % M5S Votes vs GDP per Capita

Inequality Provides Fertile Ground for Populism

Source: Algebris (UK) Limited, UK Census, Office for National Statistics

Piemonte

Valle d'Aosta/Vallé

e d'Aoste

Liguria

Lombardia

Provincia Autonoma di

Trento

Veneto

Friuli-Venezia Giulia

Emilia-Romagna

Toscana

Umbria

Marche

Lazio

Abruzzo

Molise

Campania

Puglia

Basilicata

Calabria

Sicilia

Sardegna

R² = 0.8482

0%

10%

20%

30%

40%

50%

60%

10,000 15,000 20,000 25,000 30,000 35,000 40,000

% Votes to M5S

GDP per capita, Euro

The Demographics That Drove Brexit


Page 18

Overhangs: Is Italy’s Debt Sustainable?

Fragile Debt Dynamics: Italy

Source: Algebris (UK) Limited, IMF, Bloomberg.*Assuming an average annual primary surplus of 1.47% of GDP (long-run average for Italy since 1988); assuming 10% of total debt will be refinance every year.

Italy Debt to GDP Ratio in 5 Years in Different Growth and Yield Scenarios

Red Cells = Debt to GDP Ratio > 130%

Average Annual Nominal GDP growth

Yie

ld C

ha

ng

e

-5% -4% -3% -2% -1% 0% 1% 2% 3% 4% 5%

-1.0% 187% 177% 168% 159% 151% 143% 136% 129% 122% 116% 110%

-0.5% 188% 178% 169% 160% 152% 144% 137% 130% 123% 117% 111%

0.0% 189% 179% 170% 161% 153% 145% 138% 131% 124% 118% 112%

0.5% 191% 181% 171% 162% 154% 146% 138% 131% 125% 119% 113%

1.0% 192% 182% 172% 163% 155% 147% 139% 132% 126% 119% 114%

1.5% 193% 183% 173% 164% 156% 148% 140% 133% 127% 120% 114%

2.0% 195% 184% 175% 166% 157% 149% 141% 134% 127% 121% 115%

2.5% 196% 185% 176% 167% 158% 150% 142% 135% 128% 122% 116%

3.0% 197% 187% 177% 168% 159% 151% 143% 136% 129% 123% 117%

3.5% 198% 188% 178% 169% 160% 152% 144% 137% 130% 124% 117%

4.0% 200% 189% 179% 170% 161% 153% 145% 138% 131% 124% 118%


Page 19

Socio-economic Imbalances Grow

Fragile Politics: UK

6th highest income inequality amongst OECD members

7% privately educated Britons are:

- 71% of senior judges

- 55% of Permanent Secretaries

- 53% of Senior Diplomats

- 50% of Lords

- 44% of the Sunday Time’s ‘Rich List’

- 43% of Columnists

- 35% of the National Rugby Team

Top 1% of earners pay 27% of tax

45% of Britons from the top income quartile remain in this bracket

12% only of those in the lowest income quartile ever migrate to the highest quartile

Nobles own 1/3 of the land, nearly 30% of children live near the poverty line

Source: Algebris Investments (UK) LLP, “Elitist Britain?” UK Gov


Page 20

Policy and Investment in Times of Populism


Page

Fed Tightening Cycles End in a Burst

21

Source: Bank of America Merrill Lynch Global Investment Strategy, Bloomberg

'29Wall St crash

'37Fed

"policy mistake"

'70Penn

CentralBK

'74 Franklin Natl

BK

'82LatAm debt

'87Stock market crash '90

S&Lcrisis

'94Tequilacrisis

'00Tech

bubble

'97Asia/

Russia/LTCM

'07Subprime

crisis

0

2

4

6

8

10

12

14

16

18

20

'15 '21 '27 '33 '39 '45 '51 '57 '63 '69 '75 '81 '87 '93 '99 '05 '11 '17

US Fed Funds target rate, %

Equity volatility

EM crisis

BTP

A History of Bubbles


Page

The End of QE

Bye Bye QE (for now)

22

Source: Algebris (UK) Limited, Bloomberg, central bank websites

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

0

2

4

6

8

10

12

14

16

18

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Fed ECB BoJ BoE 12m chg (RHS)

G4 Central Bank Balance Sheets, $tn

Stock

Flow

Projections


Page

Fragility: Nature, Policy and Markets

Source: Algebris (UK) Limited. With reference and inspiration from Antifragile: Things that Gain from Disorder, N. N. Taleb (2013)

23

Fragility is Common, Anti-Fragility Rare

Fragile Robust Anti-Fragile

Medicine Anaesthesia Vaccine Mithridatism

Pension System Defined Benefits Defined Contributions Social Shock Absorbers

Technology Centralised Hard Drive Underground Storage Cloud Storage

Mythology Damocles Ulysses Hydra

Nature Dinosaurs Land Turtle Ant Colony/Bacteria

Objects Tea Set Anvil Spring

Financial MarketsPassive Investing/Herding

Financial

Engineering/Complexity

Active Management Tail Risk Strategies

Monetary Policy Forward Guidance Rule-Based Approach Macro-prudential Policy

Capital Structure Debt Equity AT1

Sovereign DebtHard Currency External

DebtDomestic Currency Debt Growth-Linked Debt

Economic Agents Politicians RegulatorsLong-Term/Contrarian

Investors

Government Structure Eurozone Singapore Switzerland


Page 24

QE and ZIRP/NIRP at the Base of the Carry Trade Pyramid

$2tn Short Vol Strategies

$8tn High-Dividend/Growth Equity

$11tn IG/HY Credit$2tn EM Hard Currency Credit

$12tn Sovereign Debt at <1% Yield*

$21tn Central Bank Balance SheetsZIRP/QE

Source: Algebris (UK) Limited, Bloomberg. *Data sourced from GS

Debt, QE and Low Volatility


Page 25

From QE to Markets

Low Volatility and Asset Bubbles


How Loose Monetary Policy Has Reduced Risk Premia and Volatility

Search for yield

QE

Lower sovereign

yields

Anticipation of more QE to

mitigate volatility reversal

(Buy on dips)

Reduced rates

volatility

Sell volatility

strategies

Low volatility trap

Portfolio

rebalancing

Lower credit

spreads

Lower credit

volatility

Compressed

volatility risk

premium

Slow monetary

normalisation


Page

10 years

ago

Source: Algebris (UK) Limited, Bloomberg, GS Research.

(1) ASW Spread for ICE BofAML US High Yield Index. 10 year range. (2) Spread of 10y5y UST yield and spread of 10y5y US CPI inflation (3) As of YE 17 (4) Assumed flat fixed 100bps AuM Fees over 10 year period. (5) ASW Spread for ICE BofAML Euro Corporate

Index. 10 year range.

26

% Passive

Strategies3

Equity Implied

Volatility (VIX)

HY Credit

Spreads1

Term

Premium2

(10Yr UST)

Equity Risk

Premium3

Price Earnings

(S&P)

100%

0%

24x

12x

100

10

1300bps

290bps

3.6%

-1.0%

6.0%

0%

38%

18.8x

24.1

325bps

0.06%

3.9%

17%

Now

13.9x

80 1093bps

1.6%

1.8%

AuM Fees4

% of Yield5

50%

0%

30.4%

8.1%

Debt, QE and Low Volatility

Investing in Times of Populism


Page

Binary Markets

Fragility

27

Source: Algebris (UK) Limited, Bloomberg

Length of High-Vol Periods

0

10

20

30

40

50

60

70

80

90

100

2007 2009 2011 2013 2015 2017

Periods during which VIX>20 VIX Index

Source: Algebris (UK) Limited, Bloomberg

0%

5%

10%

15%

20%

25%

30%

35%

40%

5-10 10-15 15-20 20-25 25-30 30-35 35-40 40-45 45-50 50-55 55-60 >60

Pre QE

Post QE

Longer periods

of low

volatility…

… but also a fatter tail

of very high volatility

Proportion of Days When VIX Falls in the Range


Page 28

Conclusions: Reforms and Revolutions


Page

Intra-EZ trade

boost % GDP

effect, 2017

Extra-EZ Trade

boost

% GDP effect, 2017

Interest saving

% 2017 GDP

Total gains as

% 2017 GDP

Germany 0.7% 4.3% 3.1% 8.1%

France 1.0% -1.3% 4.6% 4.3%

Spain 1.3% -2.6% 4.8% 3.5%

Italy 0.8% -3.0% 4.8% 2.6%

The ECB and The Eurozone

29

The EZ: A Positive-Sum Game, but Gains Are Unevenly Split

Source: Algebris (UK) Limited estimates, Eurostat, ECB, OECD, IMF, World Bank, national statistics agencies, Bloomberg


Page 30

Reforms

and

Revolutions

Rising

inequality

Growing

populism

Job

automation

Greater fiscal

spending

Lower inflation &

looser monetary

policy

Artificial

intelligence

Polarisation in skills, jobs

and income

Environment

Reforms or Revolutions?

A New Equilibrium


Page 31

Reforms and Revolutions


Past Now

Economic theories built on

assumptions of efficient markets,

unlimited natural resources and

growing populations

Markets are inefficient

Limited resources, both natural and

economic

Ageing and shrinking populations

Economics

Technology/

Job markets

Society/

Politics

Conclusions: A New Equilibrium

Technology boosts productivity

Growth always creates new jobs

Wage growth and affordable

housing

Trade deals and globalisation

Automation/A.I./sharing economy

Jobless growth, income polarisation

and lower wage growth

Low interest rates resource

misallocation low productivity

low quality & paid jobs

Phillips curve no longer working?

Asset appreciation > wage growth

Rising inequality Populism & more

inefficiencies / nationalism and

protectionism


Page 32

Reforms and Revolutions


Past Now

Western powers influence /

dominate / dictate

Emerging Powers: China, India, Middle

East. Terrorism and nuclear threatsGeopolitics

Fiscal

policy

Monetary

policy

Conclusions: A New Equilibrium

Recession fiscal stimulus

multiplier effect

“Trickle Down”

Recession lower interest rates

credit growth higher

investment and consumption

High public debt limited room for

spending

Balance sheet recession investment

and consumption no longer responsive

to interest rates given over-leverage;

consumers look at permanent future

income: low interest rates depress

savings and spending

Low interest rates today

growth and inflation high

interest rates in the future

Low interest rates today asset

bubbles and growing inequality, wage

stagnation/hysteresis, financial fragility

low interest rates in the future


Page 33

Source: Algebris (UK) Limited. “Ulysses and the Sirens”, Painting by J. W. Waterhouse, oil on canvas, 1891.

Ulysses and the Sirens


Page


Page 35

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