Money for Nothing

The persistence of low inflation across advanced economies has led central banks into the realm of zero and even negative policy rates, with the result that government borrowing (and thus spending) is now free. Populist politicians find themselves right at home, while those warning that there is no free lunch will be ignored – until it is too late.

Harold James

james159_getty images-inflation

MUNICH – A monetary-policy regime centered on quantitative easing (QE) and zero or even negative interest rates has created an extraordinarily permissive environment for politicians of a certain disposition. Those who are willing to exploit current conditions to boost their own popularity can expect clear sailing ahead – at least for now.

Throughout almost all of the advanced economies, monetary and fiscal policymaking are interacting in a new and unique way. Consider, for example, that the German government just issued 30-year bonds with a negative yield. That means it can borrow for free, and, in theory, do anything it wants – at no cost. And Germany is hardly alone, which is why it is not surprising to hear a growing chorus of voices calling for greater fiscal activism at the first sign of a growth slowdown.

Obviously, the current situation could have far-reaching monetary and distributive consequences, given that governments are gradually expropriating from the traditional rentiers. But that is just the start. Politics itself has always been about managing tradeoffs.

Money spent in one area cannot be spent somewhere else. If nurses and doctors are paid more, teachers, police, or firefighters will be paid relatively less. Governments must choose between cutting taxes and building new high-speed rail links, aircraft carriers, or roads and bridges.

But now, unconventional monetary policy has given rise to an unconventional politics. In Europe, populist governments in Central and Eastern Europe have been especially good at playing the new game. They can buy off different political factions, raise child benefits, increase pensions, reduce the retirement age, build infrastructure, and cut taxes all at the same time. If the opposition pushes new spending proposals, the government can simply adopt those ideas as its own, ensuring its hold on power.

This new blurring of monetary economics and fiscal policy will inevitably lead to dysfunction.

In the 1990s, when Europeans were considering whether to adopt the euro, the single currency was sold both as a disciplining instrument and as a means of sugarcoating the bitter tradeoffs of conventional politics. Joining the eurozone meant sacrificing some degree of sovereignty over fiscal policy; but membership would bring lower interest rates, thereby reducing the costs of government debt and freeing up resources for other uses.

Under the new dispensation, the increased temptation to spend is still there. But it comes with a new, peculiar limitation: the sugar fairy only sprinkles her magic dust on countries that pledge to remain within the circle. The moment the prospect of leaving is raised, the spell is broken, which is why even Euroskeptic politicians in Italy and France no longer entertain that option.

Of course, the euro does not magically turn member-state governments into models of economic rectitude. On the contrary, they are now effectively rewarded for acting irresponsibly and unpredictably, while forcing monetary authorities into a more accommodating position.

The most obvious example of this gambit is in the United States, where President Donald Trump’s trade war and Twitter threats are fueling economic uncertainty and putting wind in the sails of doves on the Federal Open Market Committee. The Fed is now cutting interest rates to head off a growth slowdown. It is only a matter of time before European populists – British Prime Minister Boris Johnson, Hungarian Prime Minister Viktor Orbán, and Matteo Salvini (whose ambition remains to become the Italian prime minister) double down on the same strategy.

Compounding the dysfunction, populists have latched onto new intellectual arguments, and are increasingly presenting themselves as serious, innovative thinkers. Their first task is to persuade voters that what they are doing is not dangerous. But this hasn’t been too difficult, given that voices celebrating the demise of the old liberal order are now heard across the political spectrum. Throughout the advanced economies, there is a widespread perception that since the 2008 financial crisis, the old rules have no longer applied.

The new narrative that has emerged is ideal for populists. It holds that the financial crisis discredited traditional economics, and that “neoliberalism” was a dangerous illusion. The neoliberal insight that came in for the greatest criticism after the crisis was that fiscal restraint is a virtue and rewards adherents with lower interest rates, cheaper credit, and enhanced consumer spending. According to the critics, government spending is not only free, but also an unalloyed good.

In this brave new economy, no one seems to be able to say authoritatively how much debt is dangerous. But that doesn’t mean there isn’t some level of debt that could trigger a dramatic reversal. If depositors and investors become nervous, debt could become expensive again, making the existing debt stock unsustainable. Only then will the populist magic stop working.

Those who want to restore conventional politics and the old rules find themselves in an unenviable position. Although they do not wish for an end to prosperity, they sound like they do when standing next to populists. Nobody wants to vote for Cassandra when Pollyanna is on the ballot. By the time Cassandra’s warnings are borne out, it is always already too late.


Central banks are locked in currency wars they cannot win

Lowering interest rates to support economies has created a domino effect

Seema Shah

The sun rises next to the European Central Bank at the river Main in Frankfurt, Germany, early Thursday, Aug. 22, 2019. (AP Photo/Michael Probst)
Years of aggressive monetary easing by the ECB has hacked away at interest rates © AP

Negative-yielding bonds are taking on an ever-greater chunk of the global fixed income universe and are still failing to lift economic activity. But the market continues to call for monetary policy easing from the European Central Bank and the Federal Reserve. It is not clear why central banks continue to acquiesce.

In fairness, for the ECB, the requirement for policy action is clear, given that Germany is teetering on the brink of recession. But with Bund yields already negative across the entire curve, pushing them even lower is unlikely to forestall deflation, encourage lending or nurture an economic recovery.

Years of aggressive monetary easing by the ECB has hacked away at interest rates. Negative deposit rates, rather than supporting bank lending, have instead hindered it, rendering the central bank less able to respond effectively to negative economic events with traditional monetary policy tools. Monetary policy has reached the limits of its effectiveness.

Of course, the ECB knows all this. So why does it continue to ease?

The simple answer is that easier monetary policy tends to cheapen a country’s currency and the foreign exchange channel has become one of the few ways the ECB can juice up the eurozone economy. When central banks turned to unconventional monetary policies a decade ago, driving in

terest rates to record lows, and with fiscal policy constrained by politics, it left them with little choice but to use interest rates surreptitiously to target currencies in the next downturn. This is the logical next chapter to follow quantitative easing.

A weaker euro acts as a shock absorber to cushion the blow of weak internal eurozone economics by improving external dynamics. However, it initiates a domino effect whereby other central banks must also lower their interest rates in an attempt to match the efforts of their neighbours and prevent their currencies from appreciating.

The US-China trade conflict has created more complications. China’s decision to permit renminbi depreciation as an automatic stabiliser creates friction for other Asian central banks, pressuring them to engage in competitive depreciation — a kind of beggar-thy-neighbour policy. Over the past few months, a succession of central banks has eased policy. So much for solidarity in global monetary synchronisation.

For its part, the Fed is understandably reluctant to indulge in aggressive monetary stimulus.

The US consumer has remained resilient in the face of slowing economic activity, suggesting that the problem is not that interest rates are too high.

If the Fed allows interest rates to deviate too far from the ECB’s, the US dollar will strengthen. President Trump, ever alert to the risks of other countries wanting to “take advantage” of the US, is becoming increasingly irate.

Unfortunately for him, the global economic slump creates the perfect conditions for a currency war. The US will try to participate in this race to the bottom, but it will probably be the slowest competitor.

Weakening global growth is not conducive to a downtrend in a cyclical currency such as the US dollar, and safe haven flows in these times of market turbulence have clearly amplified the upward forces on the greenback.

President Trump should look in the mirror — it is the homegrown trade war that is prompting investors to seek safety. What is more, with almost $16tn bonds trading at negative yields, 10-year US Treasury yields at just 1.5 per cent are relatively high. The US cannot help but attract capital, driving the US dollar higher.

The dark side of falling interest rates is the prospect of riskier investor behaviour. With negative rates in Europe and Japan, investors are searching for any kind of yield. As a result, they have little choice but to venture into the riskier corners of the bond market.

Given regulatory constraints limiting many investors to the investment grade space, US triple-B is the natural home. But if and when the US eventually hits recession, forced sellers will find that the house has a narrow and shrinking exit door.

Fiscal stimulus is an obvious circuit breaker in this race to the bottom in currencies and yields. The market is making it easy for countries to borrow more, yet governments remain strangely reluctant.

Companies are also failing to take advantage of negative yields. To date, only a handful have locked them in the primary market. Businesses appear to be worried about the economic environment and the risks they face in taking on more leverage.

Yet, if the domination of negative yields is sustained, companies will surely focus on bond markets rather than equity markets. Why, when you can be paid to borrow, would you look to public offerings instead?

This would create a unrecognisable environment: the pipeline of investible public companies could essentially dry up. Unviable companies would be granted extended lifelines, propped up by high valuations solely based on record low debt rates.

Is this the world central banks were hoping to create when they started out on the long road of unconventional monetary policy all those years ago?

Seema Shah is chief strategist at Principal Global Investors.

Trump’s Effect on US Foreign Policy

Donald Trump's long-term impact on US foreign policy is uncertain. But the debate about it has revived a longstanding question: Are major historical outcomes the product of human choices or are they largely the result of overwhelming structural factors produced by economic and political forces beyond our control?

Joseph S. Nye, Jr.

nye194_NICHOLAS KAMMAFPGetty Images_trump

CAMBRIDGE – US President Donald Trump’s behavior at the recent G7 meeting in Biarritz was criticized as careless and disruptive by many observers. Others argued that the press and pundits pay too much attention to Trump’s personal antics, tweets, and political games. In the long run, they argue, historians will consider them mere peccadilloes. The larger question is whether the Trump presidency proves to be a major turning point in American foreign policy, or a minor historical blip.


Some analysts liken the flow of history to a rushing river, whose course is shaped by the climate, rainfall, geology, and topography, not by whatever the river carries. But even if this were so, human agents are not simply ants clinging to a log swept along by the current. They are more like white-water rafters trying to steer and fend off rocks, occasionally overturning and sometimes succeeding in steering to a desired destination.

Understanding leaders’ choices and failures in American foreign policy over the past century can better equip us to cope with the questions we face today about the Trump presidency. Leaders in every age think they are dealing with unique forces of change, but human nature remains. Choices can matter; acts of omission can be as consequential as acts of commission. Failure by American leaders to act in the 1930s contributed to hell on Earth; so did refusal by American presidents to use nuclear weapons when the United States held a monopoly on them.

Were such major choices determined by the situation or the person? Looking back a century, Woodrow Wilson broke with tradition and sent US forces to fight in Europe, but that might have occurred anyway under another leader (say, Theodore Roosevelt). Where Wilson made a big difference was in the moralistic tone of his justification, and, counterproductively, in his stubborn insistence on all or nothing for involvement in the League of Nations. Some blame Wilson’s moralism for the severity of the America’s return to isolationism in the 1930s.

Franklin D. Roosevelt was unable to bring the US into World War II until Pearl Harbor, and that might have occurred even under a conservative isolationist. Nonetheless, Roosevelt’s framing of the threat posed by Hitler, and his preparations to confront that threat, were crucial for American participation in the war in Europe.

After World War II, the structure of bipolarity of two superpowers set the framework for the Cold War. But the style and timing of the American response might have been different had Henry Wallace (whom FDR ditched as vice president in 1944), instead of Harry Truman, become president. After the 1952 election, an isolationist Robert Taft or an assertive Douglas MacArthur presidency might have disrupted the relatively smooth consolidation of Truman’s containment strategy, over which the latter’s successor, Dwight D. Eisenhower, presided.

John F. Kennedy was crucial in averting nuclear war during the Cuban Missile Crisis, and then signing the first nuclear arms control agreement. But he and Lyndon B. Johnson mired the country in the unnecessary and costly fiasco of the Vietnam War. At the end of the century, structural forces caused the erosion of the Soviet Union, and Mikhail Gorbachev speeded up the timing of Soviet collapse. But Ronald Reagan’s defense buildup and negotiating skill, and George H.W. Bush’s skill in managing crises, played a significant role in bringing about a peaceful end to the Cold War.

In other words, leaders and their skills matter. In a sense, this is bad news, because it means that Trump’s behavior cannot be easily dismissed. More important than his tweets are his weakening of institutions, alliances, and America’s soft power of attraction, which polls show as having declined under Trump. He is the first president in 70 years to turn away from the liberal international order that the US created after WWII. General James Mattis, who resigned after serving as Trump’s first secretary of defense, recently lamented the president’s neglect of alliances.

Presidents need to use both hard and soft power, combining them in ways that are complementary rather than contradictory. Machiavellian and organizational skills are essential, but so is emotional intelligence, which produces the skills of self-awareness and self-control, and contextual intelligence, which enables leaders to understand an evolving environment, capitalize on trends, and apply their other skills accordingly. Emotional and contextual intelligence are not Trump’s strong suit.

The leadership theorist Gautam Mukunda has pointed out that leaders who are carefully filtered through established political processes tend to be predictable. George H.W. Bush is a good example. Others are unfiltered, and how they perform in power varies widely. Abraham Lincoln was a relatively unfiltered candidate and was one of the best American presidents.

Trump, who never served in office before winning the presidency and entered politics from a background of New York real estate and reality television, has proven to be extraordinarily skilled in mastering modern media, defying conventional wisdom, and disruptive innovation.

While some believe this may produce positive results, for example with China, others remain skeptical.

Trump’s role in history may depend on whether he is re-elected. Institutions, trust, and soft power are more likely to erode if he is in office for eight years rather than four. But in either event, his successor will confront a changed world, partly because of the effects of Trump’s policies, but also because of major structural power shifts in world politics, both from West to East (the rise of Asia), and from government to non-state actors (empowered by cyber and artificial intelligence).

As Karl Marx observed, we make history, but not under conditions of our own choosing.

American foreign policy after Trump remains an open question.

Joseph S. Nye, Jr. is a professor at Harvard University and author of Is the American Century Over? and the forthcoming Do Morals Matter? Presidents and Foreign Policy from FDR to Trump.

George Friedman’s Thoughts: Passion and Aristotle’s Four Virtues

Aristotle’s virtues, like passion, have a complex and important relationship to geopolitics.

By George Friedman

Of late I have been writing on issues like passion, and some have asked what this has to do with geopolitics. Geopolitics is the dynamic between nations, but it also defines internal dynamics, where ethnicity, wealth and religion all matter. And this, in turn, relates to the family and the individual. It is not that individuals are decisive, but rather that they both shape and are shaped by the foundation of the nation. The question of passion and its basis in civilization is therefore connected to, for example, Sino-American relations in complex yet important ways.

In response to my view on passion, some argued that passion is necessary for success. But passion is a poorly defined concept. Passion can be used to describe Christ on the cross, a wealthy man’s desire for more money, or Churchill’s definition of a fanatic as someone who can’t change his mind and can’t change the subject. Passion is a form of anger that hides itself under the cloak of civility. The fanatic shows his hand; the passion that frightens me is the rage of certainty masquerading as calm.

Aquinas, Maimonides and al-Farabi all regarded Aristotle as the greatest thinker of all time, as do I. He had a simple but powerful matrix of the virtues a man must have. Aristotle never embraced passion. He spoke of passion but regarded it as far below the virtues; as he said in his work on ethics, any beast can possess passion, and men who are passionate and nothing else are beasts.

Aristotle identified four virtues and the one that was both lowest and the foundation of all others was courage. When we think of courage, we think of war. But courage went beyond that.

For Aristotle, courage was also the ability to stand alone regardless of the opinions of the many.

The need to be well-regarded would lead men to betray themselves. That is what Socrates refused to do.

But courage was also for him a necessity of everyday life. We have all lived through nights when we dreaded the coming of morning. The courage to confront the dawn and face the day is perhaps the most fundamental and necessary part of courage. Life is difficult, and death is terrifying. We live between the two and without courage could not go on. I think this is why Aristotle treated it as the most fundamental of the virtues.

But courage is also a form of madness. I remember a night in Islip on Long Island in New York. I was driving a well-seasoned Plymouth Belvedere, against a knight astride a Chevy Impala. Dying was better than flinching as we engaged in the ancient game of chicken. In the end, I swerved. We were both drunk on courage, but the prize was not a substitute for the abyss.

Aristotle despised this sort of impassioned bravery.

Aristotle’s second virtue was prudence. Prudence was intended to moderate courage; it is the scale on which courage is measured and tempered. The willingness to die is not an eagerness to die. Risking your life might be too high a price to pay for the prize. Other means might be found to satisfy the need.

Prudence alone devolves into a careful calculation that neglects the soul. Courage is indispensable to life, and prudence without courage knows the price of everything and the value of nothing. Courage without prudence is recklessness, which risks all for nothing. For the crazy brave, the risk of everything is an end in itself, and it leaves his flank uncovered. Prudence without courage is Shakespeare’s Shylock wailing over his daughter and then his money, knowing the price of each but knowing nothing of their value.

At the same time, the perfect balance of prudence and courage leaves open the end toward which prudence will guide courage. Perfectly balanced, it is the sphere of the banal man who has courage but is constantly restrained by prudence to be far less than he can be. For Aristotle there is, therefore, a third virtue: justice.

Where prudence shapes and restrains, justice demands that men act in its name. It takes the mediocrity of prudence and courage and turns it into a moral imperative. With justice, we know what we owe and to whom. Prudence now becomes a servant of justice, making certain that courage is shaped properly in pursuit of justice.

Of course, the nature of justice is itself mysterious. Is it the interests of my nation? Is it the teachings of my God? Is it a vision of perfection that other men have conceived? Is it the right of the strong to rule the weak? Geopolitics teaches that between nations there is courage and prudence, and that justice is merely the expression of the interests of each nation. If that is all that justice is, then it is far from a binding power.

To give your life to that would please the crazy brave but repel all others. Humans have a need for something truer and nobler to which to commit their lives, fortunes and sacred honor. But where is it be found? Is it in the habits of my people or in the coming of a new age wrought by revolution?

The American founders sought to solve that problem by melding habits with revolution. It has worked, but the habits and the moral principles of the revolution have always been uneasy partners. And America was invented. Justice could be invented as well, but it has always required a seductive poem to be recited, diverting our eyes from its complexity.

In all of this, then, there is a fourth virtue: wisdom. Wisdom recognizes what matters and what does not. It’s what the philosopher is said to possess. Wisdom knows that justice is absolutely necessary, and it understands that just because it is necessary does not mean that it exists. The fact that it exists does not mean that it applies in this time and place. And the fact that it applies does not mean that men will believe in it.

Wisdom understands the needs and limits of humankind and the gorgeousness of the true and the beautiful. And it understands the tragedy of being human, which is that the true and the beautiful blind the eyes of the many, so that they can only have second best – a poem that is built on the truth but expressed as a lie intended to seduce, to give the needed justice rather than the true.

Wisdom is, therefore, the highest sort of prudence, just as justice is the highest moment of courage.

Plato spoke of the noble lie. The noble lie was built on the truth that men could not bear to know and was presented to them in the form they required. The rare wise man recognizes the true and beautiful and the fact that gazing upon it would drive ordinary people mad or blind.

So, a lie is invented that rests on truth, and that lie becomes the foundation for men to be courageous. Wisdom understands the limits of truth.

It is like the story of Moses, who, on seeing the promised land, was not permitted by God to enter it because he had struck against God in anger. God knew that Moses could lead a rebellion against Egypt and God himself. But he could not govern. So, he replaced Moses with a lesser man, Joshua, who had never spoken to God but believed that God had spoken.

Joshua was a warrior, a man of courage, who prudently sent spies into Jericho. He believed in the justice of his cause, dubious though it might have been. But he was never wise as Moses had been. And that made him suitable to serve the geopolitical needs of his people, without being troubled by things that were beyond him.

Here's The Real Takeaway From The Fed Meeting

by: The Heisenberg


- Thanks to a seizure in funding markets, many desks were forced to reassess their expectations for the September FOMC meeting at the last minute.

- The only thing that mattered on Wednesday was what Jerome Powell said about the squeeze and how the Fed planned to address it.

- He was characteristically unconvincing on that score, but did manage to stumble into the "correct" answer when prodded by CNBC's Steve Liesman.

- Forget any other Fed takes you might have read. This is the real story.

You may not know (or even care to know) the specifics, but most investors are probably aware of the fact that funding markets suffered something of a seizure earlier this week.
The squeeze, which saw GC repo surge (visual below), was attributable to the collision of structural/legacy issues (e.g., Fed balance sheet runoff, Treasury supply to finance the deficit and bloated dealer balance sheets), and idiosyncratic factors (e.g., corporate tax payments, coupon settlements and last week's bond rout, the worst since the election).
The New York Fed was forced to intervene on Tuesday for the first time in a decade, after the effective funds rate was dragged through the upper end of the target range. The visual below, for those who still haven't come to terms with what happened, represents the Fed quite literally losing control of rates - albeit temporarily.
On Thursday morning, the New York Fed injected liquidity for a third consecutive day.
As I was writing this post, they announced they'd conduct a fourth operation on Friday.

The insanity (and it truly was chaotic, as detailed in Bloomberg's dramatic retelling) forced Wall Street to reassess their expectations for the September FOMC meeting at the last minute.
For the uninitiated, this can be an intimidating subject, but stick with me, because this is important - I'll keep it as brief as posible.
On Tuesday, some desks suggested the Fed might be compelled to announce its intention to expand the balance sheet imminently and/or launch a long-rumored standing repo facility.
Some high profile names got in on the act. Jeff Gundlach, for instance, said in a webcast (and also in an interview with Reuters) that the Fed would launch "QE-Lite" "pretty soon" to address the pressures that contributed to this week's funding squeeze.
The idiosyncratic factors cited above notwithstanding, the overarching issue is reserve scarcity.
BofA's Mark Cabana has been one of the most persistent voices in documenting this in near real-time over the past several months. There are people who will take you as far down into the "plumbing" as you want to go (with Zoltan Pozsar being perhaps the best example), but Cabana's cadence is relatively user-friendly as this discussion goes.
"The increase in funding pressure as reserves declined to ~$1.35tn likely suggests that the market is on the upward sloping part of the reserve demand curve, below the minimum amount of reserves needed for an ‘abundant reserve regime'," he wrote on Monday evening, as it became apparent that this week would be all about the funding squeeze. Here are two key visuals (note the X-axis is the FF-IOER spread, which you can put in the context of the second chart above):
Here is Goldman saying the same thing in a Wednesday note out prior to the Fed decision:

Until last week the relationship between FF-IOER and aggregate reserves largely seemed to track the curve imputed from the Fed’s Senior Financial Officer Survey, which suggested a substantial buffer (i.e., the “steep” part of the curve was probably at reserve levels below $1.2tn). However, at current levels of aggregate reserves (which we estimate had dropped to about $1.34tn this week), the realized FF-IOER spread, at 15bp on Monday and 20bp on Tuesday, is nearly 7bp to 12bp above where we would have anticipated it to be based on the survey.
That is what CNBC's Steve Liesman was referring to in the press conference on Wednesday when he asked Jerome Powell if the Fed might have "underestimated the amount of reserves necessary for the banking system." Powell's response was lengthy, but here's the abridged version:
We try to assess what that is. We’ve tried to combine that all together, we’ve put it out so the public can react to it. But yes, there’s real uncertainty and it’s certainly possible that we will need to resume the organic growth of the balance sheet earlier than we thought. That’s always been a possibility and it certainly is now. Again, we’ll be looking at this carefully in coming days and taking it up at the next meeting.
Powell's remarks amounted to an acknowledgement that the Fed will need to expand the balance sheet imminently, but the nuance (i.e., the "organic" bit) is crucial and I'll get to that below.
As far as the amount goes, BofA's Cabana on Tuesday estimated that the Fed probably needs to buy $250bn in assets in the secondary market in order to get back to an "abundant" reserve regime with a buffer. Going forward, the Fed would need to persist in outright purchases of around $150bn/year to maintain that level. That gives you an idea of the scope.
It's not a coincidence that stocks turned around as Powell discussed this during the press conference. And indeed, Nomura's Charlie McElligott suggested ahead of time that because the nuance around this isn't well understand, many market participants would rely on "muscle memory" conditioned over the post-crisis years to buy on any headlines around balance sheet expansion. "If we get a 'Fed balance sheet expansion' headline, the equities market risks an overly-bullish interpretation," he wrote, in a Wednesday morning note.
Although we did not, in fact, get an announcement of balance sheet expansion, Powell's discussion during the press conference was seen as confirmation that it's coming, and probably son.
And yet, it's crucial that investors understand that this isn't really "QE", per se. One commenter elsewhere claimed that Powell had left "QE Easter eggs" in his remarks at the presser. That is indicative of the general investing public not understanding the dynamic.
Here's McElligott again (from a Thursday note):
The danger near-term however is that so many in markets equate “balance sheet expansion” to a resumption of “outright QE” and LSAPs…despite a much more nuanced “organic growth” / “QE-Lite” message from Chair Powell at this juncture to “offset +” further Reserve depletion—thus a risk of a near-term bullish sentiment overshoot surrounding this misnomer of “balance sheet expansion = QE.
So, again, you have to understand this in the context of this week's funding squeeze which itself has to be couched in terms of reserve scarcity and an apparent miscalculation of what level of reserves count as "ample."
The September FOMC statement and the dots betrayed a divided committee. Frankly, it doesn't even make sense to speak of "forward guidance" when it comes to the Powell Fed. One is lucky to be able to divine anything about what went into this meeting's decision, let alone what's coming next. The dissents (Rosengren and George in favor of staying on hold, Bullard in favor of a larger cut) don't help.
But really, that was beside the point on Wednesday. What mattered was that the Fed definitively address the funding squeeze or, barring the announcement of balance sheet expansion or a standing repo facility, that Powell demonstrate during the press conference that he takes the situation seriously.
Instead, we got another IOER tweak, the promise of ad hoc, "as needed" liquidity injections (i.e., the operations the New York Fed conducted on Tuesday, Wednesday, Thursday and will conduct on Friday) and remarks from Powell that were anything but forceful.

The IOER tweak and the overnight repo operations are Band-Aids, almost by definition. They buy time, that's all. To address the issue sustainably requires balance sheet expansion, one way or another.
As far as Powell goes, here is another excerpt from his response to Liesman (you can watch the exchange here):
Of course, we were well aware of the tax payments and also of the settlement of the large bond purchases. And we were very much waiting for that. But we didn’t expect … The response to that was stronger than we expected. And by the way, our sense is that it surprised market participants a lot too. I mean, people were writing about this and publishing stories about it weeks ago. It wasn’t a surprise, but it was a stronger response than, certainly than we expected. So, no, I’m not concerned about that, to answer your question.
He elaborated further, but his response was wholly insufficient in my judgement, and I'm hardly alone in that assessment.
Irrespective of whether you think Powell managed to come out unscathed thanks to the reference to balance sheet expansion (and, again, equities' response to that was likely a reflection of market participants not fully understanding the situation) please note that if you read any account of Wednesday's press conference that suggests the Fed chair threaded any needles or otherwise navigated these choppy waters deftly, those accounts are not accurate.
Here, for instance, is what TD rates strategist Priya Misra said as Powell spoke (this was carried on the Bloomberg terminal):
This is disappointing. He is not addressing the structural issues at all. He is not acknowledging the reserve scarcity point and in fact says that we are operating at an ample reserve regime. I expect repo vol to stay high and then rise again at quarter end and year end.
Not every account was as critical as that one, but the fact is, there were no needles threaded on Wednesday. There was just Powell stumbling his way through another somewhat painful press conference, dodging questions when the going got tough and coming across as insufficiently concerned about the only thing that really mattered this week - the funding squeeze.

All of that said, you should also be wary of accounts that suggest this week's turmoil in funding markets represents some kind of 2008-style freeze-up. That isn't the case for a variety of reasons.
Here's a simple assessment from a much longer Credit Suisse note:
What we have seen this week is not a crisis but a symptom that we have reentered an old regime for Fed policy operations. To answer the question, is the Fed losing control, we say no it isn’t, but it must now move to allowing its balance sheet to grow in order to maintain its interest rate target.
And therein lies the problem. What the market got on Wednesday was an IOER tweak and a promise of ad hoc liquidity injections in perpetuity. They're putting duct tape over an earthquake fissure.
That characterization isn't meant to suggest that temporary measures can't close the fissure for a spell, or that the fissure is going to widen out and swallow us all. Rather, it's just to say that the issue at the heart of this week's funding squeeze wasn't addressed in a sustainable way at the September Fed meeting.
Going forward, the important thing will be for the Fed to communicate effectively ahead of the inevitable announcement of balance sheet expansión.
This is a subject that is poorly understood by most, and understood down to the granular details by a relative handful of rates strategists and those active in money markets. That means the Fed is walking a (very) fine line between educating the 99% of people who don't understand (so as to avoid accidentally creating the impression that "QE 4" is about to be launched), and convincing the 1% of people who do understand that the Fed isn't asleep at the wheel and appreciates the urgency of addressing reserve scarcity.
I wish them the best of luck in that endeavor and I wish you the best of luck in re-reading this post from the beginning so that you can be sure you're a well-informed investor.

Why central bankers may be hurting rather than helping lenders

Cutting rates below zero distorts the market for banks and for investors

Huw van Steenis

The European Central Bank in Frankfurt © EPA-EFE

As central bankers weigh up cutting interest rates deeper into negative territory, investors should consider when the risks of this trend will begin to outweigh its benefits.

With almost $17tn of negative-yielding debt already out there, I fear we have already hit the reversal rate — the point at which accommodative monetary policy “reverses” its intended effect and becomes contractionary for the economy.

Conventional macroeconomic models typically take banks and other intermediaries for granted. As a result, the overall benefits of cutting rates below zero may have been exaggerated.

Like steroids, unconventional policy can be highly effective in short dosages, but just as long-term usage of steroids weakens bones, so below-zero rates can weaken the financial system.

Negative rates erode banks’ margins and distort their incentives. They encourage lenders to seek out opportunities overseas rather than in their home markets. They also risk disrupting bank funding.

All these effects run counter to the central banks’ desire to ease credit conditions and support financial stability. How policymakers assess where and when the reversal rate kicks in will be pivotal to how investors should weigh up different policy packages from the European Central Bank and others.

Japanese banks, and more recently their European counterparts, have illustrated some of the problems caused by cutting rates. Japan’s regional banks have among the lowest returns on assets of any around the world.

Larger banks have fared somewhat better, in part by lending more overseas. Japanese banks bought about a third of the higher-rated tranches of US collateralised loan obligations — investment vehicles that buy leveraged loans — in the past few years.

Quantitative easing programmes have helped the global economy and enabled banks to repair their balance sheets. Low rates have improved the affordability of their loans, reduced bad debts and lifted the value of assets.

Japanese banks have relied upon capital gains from owning government bonds to offset pressures on profitability. But increased ownership of bonds can become a dangerous dynamic, a phenomenon known as a “doom loop”, magnifying the effects of swings in prices.

Lower profitability also reduces the ability of banks to upgrade their technology and enhance cyber defences, storing up future risks to financial stability.

Suppressing bad debts in the eurozone via QE has been useful for the banks, but this has largely come from indirect benefits, such as by reducing the difference in yield between German and, for example, Italian bonds. If central bankers really want to help increase the flow of credit, then buying the banks’ own debt as part of QE, which is still a taboo for the ECB, may be a better option than cutting rates further.

One counterargument is that the impact of negative rates appears to have been fairly benign in Sweden, Denmark and Switzerland, through the tiering of rates, where only part of banks’ reserves at the central bank are penalised. While these measures help, they are no panacea.

Banks have sought to offset negative rates by charging higher fees, repricing mortgage spreads and, in some cases, lending more aggressively. The longer the experiment lasts, the more Danish and Swiss banks are having to pass on negative rates to clients.

These tiering schemes were explicitly designed as foreign exchange policies, to deter inflows and protect banks. The spillover effects via the currency need to be weighed carefully. Should the ECB follow the Danish model, it may inadvertently exacerbate investors’ trade war concerns.

Pension funds’ asset allocations are increasingly being distorted by negative rates, too. One of the most striking consequences has been to encourage investors out of Japanese and more recently European markets and into US credit and equities instead. The thirst for yield has led to a self-reinforcing bid for longer-dated bonds.

As most savers target a particular level of retirement income, the lower rates go the more they will need to save to hit their targets, reducing their ability to spend today.

Investors are no longer sure how low rates might go in a range of countries. As long as this uncertainty remains, it is hard for banks to know whether the loans they are making are economically sensible or for investors to price the securities of financial institutions with confidence.

The assumption of a world without financial friction has been a fundamental weakness in much macroeconomic analysis. Where the reversal rate may be, and how long companies can endure these conditions, should be central to the policy debate. Otherwise, central bankers could end up doing more harm than good.

Huw van Steenis is senior adviser to the chief executive of UBS.

Professor Charles Goodhart of the London School of Economics also contributed to this article.

The Saudi oil crisis, volatile leaders and the risk of escalation

All sides have an interest in compromise — but that does not mean it will happen

Gideon Rachman

© FT montage/Getty

For decades, any list of global geopolitical risks will have had “attack on Saudi oil facilities” near the top. Now it has happened.

The good news is that the world is less vulnerable to an oil price shock than it was in the 1970s, when the Opec oil embargo created turmoil in the global economy. It is also true that all of the major powers involved — Saudi Arabia, Iran and the US — have strong incentives to avoid an all-out conflict.

The bad news, however, is that the key decision makers in this particular drama — Donald Trump, the US president, Mohammed bin Salman, the crown prince of Saudi Arabia, and the leadership of Iran — are all headstrong and prone to taking risks.

It is likely that, if the US sticks to its claim that Iran was behind the attack, it will stage a military response. If and when that happens, there are no guarantees that the conflict will not escalate further. Given that the weekend attacks have already caused a 20 per cent spike in the price of oil, the potential for further mayhem on the markets is clear.

The importance of Gulf oil to the wider world has been imprinted on the collective memory of the west ever since Opec imposed an embargo in 1973. It caused oil prices to quadruple, doing serious damage to markets and the world economy. The lesson learnt — that stability of Gulf oil supplies is crucial to the world economy — helped drive the west’s ferocious response to Iraq’s invasion of Kuwait in 1990.

Almost 30 years after the first Gulf war, western economies are considerably less vulnerable than they were to disruption of oil supplies from the region. The rise of shale-oil production in the US means that American oil imports from Saudi Arabia are now just one-third of the level they were in 2003.

But less vulnerable does not mean invulnerable. There is still a global price for oil; and Saudi Arabia remains the world’s leading oil exporter. So if Saudi supply is disrupted, consumers and industries across the world will quickly feel the impact.

The vulnerability of Saudi oil facilities to attack has also just been demonstrated. If the attack was carried out by drones, as first reported, it is a shocking insight into how open advanced industrial facilities are to assault by cheap and widely available new technologies. The Saudis also have cause to worry about the safety of their water supplies. The kingdom gets around half of its drinking water from desalination facilities, one of which was targeted in a rocket attack last June.

Awareness of their vulnerability to further attack should make the Saudis wary of escalating the conflict. The kingdom’s social and political stability is also a factor; the ruling family has long fretted about the threat of internal unrest from their large Shia minority.

Despite massive military spending, Saudi Arabia has also been unable to prevail in a brutal war in Yemen — which is a much less intimidating proposition than Iran. So while the Saudis have been ardent supporters of the Trump administration’s policy of “maximum pressure” on Iran, they have minimal interest in an actual war.

Iran also has a strong interest in avoiding an all-out conflict, which would expose the country to the firepower of their well-armed Gulf neighbours and, above all, to attack from the US. In recent months, the Iranians have staged an array of provocations including seizing western oil tankers in the Gulf and (probably) encouraging its Houthi allies in Yemen to hit soft targets in Saudi Arabia.

But this kind of Iranian brinkmanship has been interpreted by most western Iran-watchers as an effort to demonstrate that Tehran is not powerless in the face of sanctions. The Iranians were also seen as attempting to gain leverage ahead of a possible resumption of talks with the US.

As for Mr Trump, despite his bellicose rhetoric, the US president’s most recent actions have shown that he is keen to make a diplomatic breakthrough with Iran. One important reason that Mr Trump fired John Bolton last week is that his former national security adviser was too hawkish and opposed suggestions that American sanctions on Iran should be eased in the interests of getting talks started.

So all sides have economic and strategic interests to step back from the brink. Unfortunately, all sides have also shown themselves to be erratic, emotional and prone to miscalculation.

Saudi Arabia’s Prince Mohammed has demonstrated his own propensity for violent miscalculation through his conduct of the Yemen war and by apparently authorising the gruesome murder of the journalist, Jamal Khashoggi. As for the Iranians, if they did indeed authorise an attack on Saudi oil facilities they have taken an enormous risk, with consequences they cannot control.

Mr Trump’s volatility has been amply demonstrated. The US president’s willingness to rip up the Iran nuclear deal — but then sack his most hawkish adviser on Iran — also does not inspire confidence that he knows what he is doing. It also means that the White House is entering what could be the biggest security crisis of the Trump years, with no national security adviser in place.

Ever since Mr Trump’s election in 2016, nervous observers have wondered how the president would behave in a real foreign policy crisis. We are about to find out.

A Dollar for Argentina

Argentines prefer to hold greenbacks. Why not bury the peso?

By The Editorial Board

Argentina is back in the soup, as it so often is. The prospect that Peronists might retake power has Argentines fleeing the peso for dollars, and on Monday the center-right government of PresidentMauricio Macriimposed capital controls. Here’s a better idea: Replace the peso with the U.S. dollar as Argentina’s legal tender.

The actual election is in October but the August primary victory of left-wing populists—presidential candidateAlberto Fernándezand his running mate, former presidentCristina Kirchner —has triggered a monetary panic. The demand for dollars has soared, the peso has fallen some 20% against the dollar, and central bank reserves are declining.  

President Macri has done nothing to shore up confidence. After the primary vote foreshadowed a likely defeat in his bid for a second term, he announced a gasoline price freeze, a minimum-wage hike and new subsidies for special interests. This Peronism-lite did nothing to restore government credibility.

Last week Argentina failed to roll over its maturing dollar-denominated debt, and candidate Fernández, who is promoting the impression of chaos, said the country is in “virtual default.” The capital controls will limit access to dollars for businesses and individuals. Exporters will be required to bring their hard-currency earnings back to Argentina.

Argentina needs access to capital markets but its history of stiffing creditors makes it high risk. EconomistSteve Hankerecently wrote in Forbes that Argentina had “major peso collapses” in 1876, 1890, 1914, 1930, 1952, 1958, 1967, 1975, 1985, 1989, 2001 and 2018. Each time Argentines have had their savings, earnings and purchasing power diminished.

Now the government is telling investors that if they put their money in Argentina, they can’t be certain they can take it out. This is sure to be a drag on growth. The economy is expected to contract this year and next.

Dollarizers face resistance from the Peronist party, which relies on the inflation tax to fund its populism when revenues run low. Yet demand for dollars suggests that Mr. Macri would have popular backing for adopting the greenback as the national currency. Lawyers in Argentina differ about the legality of dollarization under the Argentine constitution, but our sources believe Mr. Macri could dollarize with the backing of a majority in Congress.

Panama has used the dollar as legal tender since 1904, and El Salvador and Ecuador dollarized in 2000. Ecuador did it to resolve a banking crisis and El Salvador did it to bring down interest rates. El Salvador and Panama now have the lowest domestic borrowing rates in Latin America and the longest maturities. Ecuador has price stability not seen in at least a half century.

One objection to dollarization is that Argentina would lose the profits a central bank earns by printing its own currency, known as seigniorage. But this is a political excuse disguised as economics. What is lost in seigniorage will be more than offset by ending peso crises.

Setting the right exchange rate also matters. Several Argentine economists propose converting short-term government paper to longer-term bonds to reduce the number of pesos that need to be exchanged for dollars in the short run. But the best rate is probably the black-market rate where the peso now trades.

Dollarization eliminates the moral hazard that central-bank rescues encourage in the banking system; international capital markets become the lender of last resort. Another benefit is that it would be nearly impossible to reverse, unlike Argentina’s one-to-one convertibility law with the dollar of the 1990s, which politicians violated when they were back in hock in the early 2000s. Argentines also ought to have the right to keep their dollars abroad if they choose. This would alleviate the worry that the government might “corral” bank accounts as it did in 2001.

A Macri decision to dollarize would break this ugly cycle by giving Argentines a store of value and a medium of exchange they can rely on. It might not save his Presidency, but it would ensure a legacy for Mr. Macri as the leader who dared to defend Argentine savings from a marauding future government.

Dousing the Sovereignty Wildfire

In time, the current spat between French President Emmanuel Macron and his Brazilian counterpart Jair Bolsonaro regarding the Amazon rainforest may become a mere footnote. But other rows between collective and national interests are sure to erupt, and the world needs to find a way to manage them.

Jean Pisani-Ferry

pisaniferry101_Brent StirtonGetty Images_fire

PARIS – On the eve of the recent G7 summit in Biarritz, French President Emmanuel Macron described the Amazon rainforest as “the lungs of our planet.” And because the rainforest’s preservation matters for the whole world, Macron added, Brazilian President Jair Bolsonaro cannot be allowed “to destroy everything.” In reply, Bolsonaro accused Macron of instrumentalizing an “internal” Brazilian issue, and said that for the G7 to discuss the matter without the countries of the Amazon region present was evidence of a “misplaced colonialist mindset.”

The dispute has since escalated further, with Macron now threatening to block the recently concluded trade deal between the European Union and Mercosur, unless Brazil – the largest member of the Latin American trade bloc – does more to protect the forest.

The Macron-Bolsonaro dispute highlights the tension between two big recent trends: the increasing need for global collective action and the growing demand for national sovereignty. Further clashes between these two forces are inevitable, and whether or not they can be reconciled will determine the fate of our world.

Global commons are nothing new. International cooperation to fight contagious diseases and protect public health dates back to the early nineteenth century. But global collective action did not gain worldwide prominence until the turn of the millennium. The concept of “global public goods,” popularized by World Bank economists, was then applied to a broad range of issues, from climate preservation and biodiversity to financial stability and Internet security.

In the post-Cold War context, internationalists believed that global solutions could be agreed upon and implemented to tackle global challenges. Binding global agreements, or international law, would be implemented and enforced with the help of strong international institutions. The future, it seemed, belonged to global governance.

This proved to be an illusion. The institutional architecture of globalization failed to develop as advocates of global governance had hoped. Although the World Trade Organization was established in 1995, no other significant global body has seen the light since then (and the WTO itself does not have much power beyond arbitrating disputes). Plans for global institutions to oversee investment, competition, or the environment were shelved. And even before US President Donald Trump started questioning multilateralism, regional arrangements began restructuring international trade and global financial safety nets.

Instead of the advent of global governance, the world is witnessing the rise of economic nationalism. As Monica de Bolle and Jeromin Zettelmeyer of the Peterson Institute found in a systematic analysis of the platforms of 55 major political parties from G20 countries, emphasis on national sovereignty and rejection of multilateralism are widespread. When John Bolton, the current US national security adviser, wrote in 2000 that global governance was a threat to “Americanism,” many regarded the idea as a joke. Few are laughing now.

True, nationalism hasn’t won the war. Despite Brexit and the rise of far-right parties in Italy and other countries, the European Parliament election in May did not produce the feared populist landslide. Growing segments of public opinion simply want policymakers to address problems in the most effective way, including at European or global level if needed.

Nowadays, however, international collective action cannot be based on further universal treaty-based obligations. The question, then, is which alternative mechanisms can address global challenges effectively while minimizing encroachments on national sovereignty.

Some models are already at work internationally. On trade, for example, burgeoning “variable-geometry” groupings are tackling new issues related to “behind-the-border” regulations such as technical standards, and the blurring of the distinction between goods and services. Corporate giants’ global abuse of market power is being confronted by the extraterritorial rulings of national competition authorities.

Likewise, the effective strengthening of bank capital ratios resulted not from any international law, but from the voluntary adoption of common, non-binding standards. And although the world is lagging on climate-change mitigation, the 2015 Paris climate agreement has prompted several countries to act, including by mobilizing regional and city governments, and triggering private investment in clean technologies.

But because not all global problems are alike, such mechanisms will provide a suitable template for collective action only in certain cases. When the various players are willing to act, a modicum of transparency and trust-building is sufficient to ensure cooperation. In other cases, however, the temptation to free-ride or abstain can be countered only by powerful incentives or even sanctions.

That brings us back to the Amazon fires. The interests of Brazil and the international community are not aligned. For Brazil’s small farmers and big agri-food corporations, the economic value of the land matters considerably. But the rest of the world is mainly concerned with the rainforest’s ecological and biodiversity value.

Time horizons also differ: unsurprisingly, the wealthy in the Global North value the future more than the poor in the Global South do. Even if large segments of Brazilian society value the preservation of the rainforest, it is wishful thinking to believe that moral suasion and nudges alone will resolve differences between Brazil and its external partners.

In the case of the Amazon, the only hard instruments available are money and sanctions. Through the transfer of more than $1 billion to the Amazon Fund since 2008, Norway already subsidizes the preservation of the environmental service that the rainforest provides to the world (it interrupted transfers last month in protest against Bolsonaro’s policies). Macron’s alternative is to coerce Brazil into valuing the environment by making trade deals and other international agreements conditional upon the country managing its natural resources sustainably.

Both options are problematic. Payments open an enormous Pandora’s box, and reaching a significant scale requires an agreement on who will actually bear the burden: the annual social value of carbon capture by the Amazon rainforest is hundreds of times larger than the Norwegian transfers. Coercion is also tricky, because there is only an oblique logical relationship between deforestation and trade. But because there are no other options, solutions will probably have to involve some combination of the two.

In time, the Macron-Bolsonaro spat may become a mere footnote. But other disputes pitting global concerns against national sovereignty are sure to erupt, and the world needs to find a way to manage them.

Jean Pisani-Ferry, a professor at the Hertie School of Governance (Berlin) and Sciences Po (Paris), holds the Tommaso Padoa-Schioppa chair at the European University Institute and is a senior fellow at Bruegel, a Brussels-based think tank.

Jeremy Corbyn’s plan to rewrite the rules of the UK economy

The Labour leader’s proposals represent a fundamental redistribution of income and power in the UK

Jim Pickard and Robert Shrimsley

“They looked like they were meeting the Gremlins”, is how one of Labour’s Treasury team remembers a meeting with senior UK civil servants ahead of the 2017 election. Jeremy Corbyn’s party was yet to surge in the polls and expected to take a thorough beating. For the officials, required to meet the opposition ahead of an election, this was a matter of going through the motions.

Two years on with UK politics scrambled by Brexit, the landscape is unrecognisable. A Corbyn government is no longer a remote prospect.

Yet John McDonnell, Labour’s shadow chancellor and the man driving its economic strategy, has not forgotten the experience. It confirmed what he always assumed, that much of the civil service, like the rest of the British establishment, is instinctively inimical to the party’s agenda.

Treasury officials, he says, will be forced to learn “a wider range of economic theories”. If Mr Corbyn does indeed lead his party to power, they are not the only ones in for a lesson.

A Corbyn government promises a genuine revolution in the British economy. Labour’s leadership intends to pursue not only a fundamental change in ownership and tax but a systemic effort to embed reform in a way that future parties will struggle to unpick.

“We have to do what Thatcher did in reverse,” says Jon Lansman, founder of the Corbyn support group Momentum. “We have to take decisive steps to both achieve a significant redistribution and create a constituency of an awful lot of people with an obvious stake in a continuing Labour government.”

LONDON, ENGLAND - OCTOBER 11: Trains arrive at and depart from Clapham Junction Station during the morning rush hour on October 11, 2018 in London, England. The Office of Road and Rail released its annual report on UK rail finance today. Net government support of the rail industry totalled Â£6.4billion in 2017-18 (not including Network Rail loans). This was Â£601million higher than 2016-17. The government received a net contribution from the train operating companies of Â£223million compared with Â£776million in the previous 12 months. (Photo by Jack Taylor/Getty Images)
Labour has announced plans to nationalise rail, water, mail and electricity distribution companies, in addition to higher taxes on the rich © Getty

At the heart of everything is one word: redistribution. Redistribution of income, assets, ownership and power. The mission is to shift power from capital to labour, wresting control from shareholders, landlords and other vested interests and putting it in the hands of workers, consumers and tenants. “We have to rewrite the rules of our economy,” says Mr McDonnell. “Change is coming.”

David Willetts, a former Conservative cabinet minister who now chairs the Resolution Foundation think-tank, says Brexit has made it harder to paint Labour’s plans as risky. “Brexit is so radical and such a massive gamble, breaking a 40-year trading arrangement, that it’s hard for Tories to say to people ‘don’t gamble on Labour’,” says Lord Willetts. “They just think: ‘who’s the gambler?’”

Over the next week, the FT will be examining the impact of a prospective Corbyn government on the UK economy, exploring the intellectual underpinnings of Corbynism and examining the feasibility and price tag of the planned reforms.

Understandably, those who are doing well out of the existing arrangements are nervous. Matthew Fell, the CBI’s chief UK policy director, says: “The question on the lips of any international investor looking at the UK, is ‘what would a Labour government mean for the economy?’ From company ownership to taxation, they want to know that their investments will be safe.”
BIRMINGHAM, ENGLAND - NOVEMBER 23: An array of To Let signs adorn properties to rent in the Selly Oak area of Birmingham on November 23, 2016 in Birmingham, England. Chancellor of the Exchequer, Philip Hammond is due to deliver his autumn statement to MPs later today. It is expected that he will ban lettings agents in England from charging fees to tenants. Philip Hammond will say that shifting the cost to landlords will save 4.3 million households hundreds of pounds. (Photo by Christopher Furlong/Getty Images)
The shadow chancellor has set out plans to build 1m social homes and sharply increase the minimum wage © Getty

Mr McDonnell, the architect of the economic agenda, has been careful to avoid causing too many controversies. But even the plans already announced are breathtaking in scope: the nationalisation of rail, water, mail and electricity distribution companies; significantly higher taxes on the rich; the enforced transfer of 10 per cent of shares in every big company to workers; sweeping reform of tenant rights; and huge borrowing to fund public investment.

But this may be just the start. The leadership is also studying an array of even more radical ideas, including a four-day week, pay caps on executives, an end to City bonuses, a universal basic income, a “right to buy” for private tenants and a shake-up in the way that land is taxed to penalise wealthy landlords.

To supporters this is about fairness; about reorienting an economy that works for those at the top but not for the young, the unemployed or those struggling on zero-hours contracts.

To his opponents and those likely to be at the sharp end of such a programme — high-earners, business owners, investors and landlords, it is alarming. “Whenever we hold events I always ask, ‘what are you more worried about, a Corbyn government or a no-deal Brexit?’” says one business lobbyist. “Now the universal answer is Corbyn.” Terry Scuoler, former head of Make UK, the manufacturers’ organisation, has described the prospect of a Labour government as “nightmarish”.
The Labour Party's shadow Chancellor of the Exchequer John McDonnell speaks to party leader Jeremy Corbyn at the party's conference in Liverpool, Britain, September 24, 2018. REUTERS/Phil Noble - RC17CDB30800
Jeremy Corbyn, head of the Labour party, with John McDonnell, the shadow chancellor and man driving the party's economic strategy, © Reuters

It is not hard to understand their fears. Influential figures within the leadership now include former members drawn from various Trotskyite factions. The trade union Unite has a dominant role in the Labour leader’s inner circle. Mr Corbyn’s past opposition to Nato and the Trident nuclear deterrent and his onetime support for the Venezuelan regime continue to cause concern.

Already, the shadow chancellor has set out plans for £49bn of new taxes and extra spending a year, borrow £250bn to fund a National Investment Bank, nationalise a swath of utilities, rip up labour laws to help workers, build 1m social homes and sharply increase the minimum wage.

A central ambition for both the Labour leadership and its union backers is tilting the balance of power away from employers and back towards the workforce.

Where former prime minister Tony Blair accepted the Thatcherite consensus on union reform, the next Labour government would make it easier for unions to go on strike and extend full employee rights to all workers in the gig economy — such as sick pay, parental leave and protection against unfair dismissal. There are plans for workers on boards, and even staff votes for leaders of some companies. There would be a 20:1 executive pay cap for companies with government contracts.
LONDON, ENGLAND - APRIL 03: Former head of the Home Civil Service Lord Bob Kerslake speaks at a 'People's Vote' press conference on April 3, 2019 in London, England. Prime Minister Theresa May is due to meet Labour leader Jeremy Corbyn today in an attempt to agree a plan on Britain's future relationship with the EU and the withdrawal agreement. (Photo by Dan Kitwood/Getty Images)
Bob Kerslake believes Labour's manifesto pledges are 'radical' but can be delivered © Getty

Mr Corbyn has dropped plans for a “people’s QE” — printing money to pay for infrastructure — at least for now. But he would move the Bank of England from London to Birmingham and parts of the Treasury to Manchester.

There would be a host of tax rises, including higher income tax for those earning over £80,000, a new “excessive pay levy”, a £5bn-a-year financial transactions tax and a jump in corporation tax from 19p to 26p in the pound.

A recent report commissioned by the leadership, Land For The Many, suggested that the current exemption from capital gains tax enjoyed by millions of homeowners could be scrapped.

A man speaks on his phone as he walks past The Gherkin and other office buildings in the City of London, Britain November 13, 2018. REUTERS/Toby Melville - RC144545D070
Some Labour figures accuse the leader's team of not caring about the interests of the City of London © Reuters

Mr Corbyn’s Labour is a far cry from Mr Blair’s “New Labour” of 1997, which sought to convince voters of its moderation. “Back then people wanted to be reassured about things not changing too much,” says one close ally. “This time people do want change.”

The financial crisis created the opportunity the Corbynites were waiting for. Its aftermath reinforced the sense of a rigged system, establishing a direct link between the excesses of the financial services industry and the economic travails of ordinary citizens. The Labour leadership further believes the decade of low interest rates since the financial crisis has been to the benefit of speculators rather than ordinary workers.

Many executives have been pleasantly surprised by a series of meetings held with the besuited Mr McDonnell, who pledges to listen to their concerns. Labour has also benefited from the Brexit chaos, which has caused many businesspeople to re-evaluate the Conservative party’s reputation as the party of economic stability.

Yet some political analysts argue that the deceptively gentle demeanour of a longstanding Marxist should not be misinterpreted. “Change doesn’t come from people having tea at the Ritz. It comes from people storming the Ritz,” he said a few years ago.

For Labour, Brexit is also an opportunity. In his speech to the 2018 Labour conference: Mr McDonnell noted: “The greater the mess we inherit, the more radical we have to be.”

Cherie Blair looks on as her husband, Tony Blair, addresses the nation for the first time as Prime Minister in Downing Street. Labour ousted the Tories from 18 years of government with a landslide general election victory.
Tony Blair with wife Cherie. Mr Corbyn’s Labour is a far cry from Mr Blair’s 'New Labour' of 1997 © PA Archive/PA Images

It was at that same conference that Labour unveiled its most daring initiative to date: a plan to seize 10 per cent of the shares in every large company in the country — whether public, private or foreign-owned — and hand them to employees. In reality the workers would not entirely own the shares but would simply be eligible for up to £500 a year each in dividends, while the remainder would be taken by the exchequer.

Calculations by the FT and Clifford Chance can today reveal that the policy, called the “Inclusive Ownership Fund”, amounts to a £300bn raid on shareholders, albeit gradually over 10 years. “It’s the biggest stealth tax in history,” says one former member of Corbyn’s office.

Mr Corbyn and Mr McDonnell are also studying an array of other initiatives including: the break-up of the Big Four auditors; a ban on all share options and golden handshakes; curbs on the voting rights of short-term shareholders; and the public naming of all workers on over £150,000 a year. Companies that fail to meet environmental criteria could be delisted from the London Stock Exchange.
LONDON, ENGLAND - AUGUST 28: Pro-EU supporters protest on outside Downing Street on August 28, 2019 in London, England. British Prime Minister Boris Johnson has written to Cabinet colleagues telling them that his government has requested the Queen suspend parliament for longer than the usual conference season. Parliament will return for a new session with a Queen's Speech on 14 October 2019. Some Remain supporting MPs believe this move to be a ploy to hinder legislation preventing a No Deal Brexit. (Photo by Peter Summers/Getty Images)(Photo by Peter Summers/Getty Images)
Pro-EU supporters outside Downing Street recently. Labour's economic plans have been pout into perspective by the Tories' 'gamble' on Brexit © Getty

Mr McDonnell has dabbled with the idea of a universal basic income but so far has promised only a pilot scheme. He is more excited about the idea of a four-day working week, and has asked Robert Skidelsky, the economist and Keynes biographer, to produce a report: “Until the first world war people thought it entirely normal to have a one-day weekend, but when it changed to two days the sky didn’t cave in,” says one ally.

Labour would also take an unconventional approach to trade. John Hilary, who is acting international liaison for Labour, has called trade deals a “new form of imperialism” and a type of “plunder”. At one event he said that “we reject the whole principle of free trade”.

By conventional yardsticks, the Labour leader’s political views would keep him from Number 10. His personal ratings are among the lowest ever seen for an opposition leader, while the public remains sceptical about Labour’s economic credibility.

Polling data show that voters currently evince little enthusiasm for a Corbyn government. And yet the existential shock of Brexit, combined with his appeal to younger voters and families fatigued by nearly a decade of austerity, could still deliver the unexpected.

Chart showing UK parties poll

For all the current woes Labour is still the party most likely to benefit from a decline in support for the Tories. But there are questions about how much of the Corbyn-McDonnell policy platform can be carried out in a single term, especially if Labour failed to win a majority.

“There must be a reasonably high prospect that they are a minority government,” says Bob Kerslake, former head of the civil service, who is helping Labour to prepare for government. “They will have to think about the implications of that for the delivery of their manifesto.”

While some in the business community have welcomed Labour’s plans for greater investment in infrastructure projects and for a more muscular industrial strategy, executives in a multitude of industries are now growing uneasy as they pay closer attention to the potential impact of a Labour government in terms of regulation, tax and red tape.

“I would be worried about Jeremy Corbyn, John McDonnell and Seumas Milne, they don’t give a fuck about the City of London,” says one senior Labour figure. “I think a lot of money would be shifted out on day one. There are a lot of people who are worried about the future financial security of the City.”

In recent weeks it has become clear to investors in water companies, the National Grid, projects funded by the private finance initiative, and the Royal Mail that a Labour government would not pay them the market price of their shares when nationalisation takes place.John Allan, president of the CBI, urged Labour in May to drop its “ideological positioning”, warning that the nationalisation plans are being watched by investors around the world. “People are now asking: is my money, my savings, my income at risk?” he asked. Mr McDonnell accused the CBI of ignoring the public clamour for change and “continuing to put shareholders first”. 
Rumours have been swirling for months about other potential candidates for nationalisation — for example, airports or BT — which have been denied by the party. Mr Corbyn, meanwhile, openly advocates the nationalisation of parts of the struggling steel industry. Senior Labour officials believe there is a huge public appetite for state ownership of industries: one points to a recent survey by the Legatum Institute suggesting that one in four people want nationalised travel agents.“Of course they can add to their manifesto commitments . . . but I’m not aware of some huge hidden list,” says Lord Kerslake.  
P23WBW The Troxy, 490 Commercial Road, London, July 6th 2016. Jon Lansman, a close Corbyn ally and founder of the Momentum campaign group, delivers a speech
John Lansman of the Corbyn support group Momentum: 'We have to do what Thatcher did in reverse' © Lee Thomas / Alamy

Mr McDonnell has tried to play down the idea that Labour would have to impose capital controls if it came to power. The issue emerged in late 2017 when the shadow chancellor said he had hired an academic to plan for various post-election crisis scenarios including a run on the pound. “I want to make it explicit that we will not introduce capital controls,” he told the FT in January.

But a 2012 pamphlet with contributions from current senior Labour figures — “Building an Economy For the People” — set out plans for capital controls. With contributions from Andrew Murray and Seumas Milne, two of Mr Corbyn’s most senior advisers, the booklet offers a range of measures to “control the flow of capital”.

“It’s a radical manifesto and it will take some delivering in one term, I think, but they will want to make significant progress on it in a first term,” says Lord Kerslake.

For the hard left, this feels like a once-in-a-lifetime opportunity. There is no appetite for timidity. “The last time that an established leading economy tried to go for a proper socialist government was [François] Mitterrand in the 1980s,” says one of Mr Corbyn’s advisers. “He said in economics there are two solutions: ‘Either you are a Leninist. Or you won’t change anything’. We want something in between, you could — to coin a phrase — call it a Third Way.”