“A hungry man is an angry man”. Unsurprisingly, I first heard the quote from a homeless man outside a Pret, in Oxford St. just behind Selfridges. He meant it quite literally. “But”, I thought, “in the western world, hunger has been mostly dealt with”. Yet the anger remains. And in the past two years it has been a constant source of worry for markets. Economists, confined by notions of “rational actors” struggle to understand, and increasingly prefer to ignore the political part of the economy, despite its genuine importance. Asset allocators remain puzzled and talk about “binary risks” which they would rather not address. So far, politics do not add risk to the portfolios. But they very well could in the future.
I grew up in Athens during the 80’s, where politics was all about balconies, flags and a charismatic populist using short and often unrelated sentences, echoing like prophetic worlds to the adoring masses. He would speak slowly, rhythmically, using many pauses, during which the background music, Karl Orf’s majestic Carmina Burana, would be turned up. Tacky, but effective. The crowds chanted in ecstasy. The economy still suffers for it. At the same time, in the US and the UK, Margaret Thatcher and Ronald Reagan followed by Helmut Kohl’s Germany, were already forging the post-Cold War world. A domain of banks, global supply chains and consumerism for all was born, confining charismatic populists to the fringes. Political technocrats presided as the cold logic of markets and Adam Smith’s “invisible hand” took over. By the middle of the 00’s, markets had stopped minding politics altogether and volatility around political events was minimal. Both left and right were pursuing similar business-friendly growth agendas, with little deviation.
Developed societies had finally evolved. The left –logical- brain had taken hold over instinct and the world seemed like a perfectly tuned machine. History, however, might argue. Aristotle had warned us that “man is a political animal” and we couldn’t ignore politics for too long. Cicero, the great Roman orator and Consul, cautioned the virtuous to become good orators, lest the crowd is left the hands of the dishonest gifted orators. It was his belief that words and sentiment, rather than logic could move a man. So it was only a matter of time before nature took over and appeals to emotion were winning voters once again. The Global Financial Crisis in 2008, catalysed this change, by shattering the dogma of unfettered free markets, as banks went hat in hand to governments asking for help.
“A hungry man is an angry man”, the homeless man told me, cajoling me into buying him a gourmet sandwich. Surely western societies have taken care of hunger, water, warmth and rest, all the basic needs, so why are people not content? Abraham Maslow, the celebrated psychologist might have an answer: Food is not enough. Once one set of needs is fully satisfied, people will move on to the next one. In his influential 1943 paper, “A Theory of Human Motivation”, Maslow theorised that after people were satisfied with the very basics, it would be safety and security that would dominate the discussion.
These are very much the issues for today’s societies. The rise of the far right or populist leaders is usually associated with migration and the perceived safety threats to the native voters. Mr. Trump won public backing after denouncing immigrants. Mr. Farage turned a referendum about an economic union into a referendum about immigration and the NHS. France’s Front National, once a fringe party, is now the country’s second biggest power. Dutch Geert Wilders came close to winning the election in Holland. Hungary and Poland now feature governments that are hostile to immigrants, refugees and sceptical about further European integration. Germany’s xenophobic AfD is the third biggest power in the Bundestag.
The left is not out Maslow’s game either, but it chooses to do battle in another step of the pyramid. Talking mostly to young people, usually less mindful of risks to their safety and security, left parties offer belongingness in a group of similar-minded people seeking to reshape the world. They would first “landscape” the current state of affairs, as a world which “leaves the week behind” and, where the demographics are favourable and where have disappointed, the left offers a vision of a better, more inclusive world. In modern “social influence” science, this is called a “phantom”, a choice which is not really available but would still sway people to towards a watered down realistic version of it.
As long as people seek to climb the hierarchy of needs, populist candidates will offer them a ladder, and belongingness and security insecurities will give people enough courage to climb it. Whether this is to the detriment of the status quo, or not, is of little consequence to those who act on instinct. In Robert Heinlein’s words “you can sway a thousand people by appealing to their prejudices, faster than you can sway one person by appealing to their logic”.
Democracy is far from perfect. Ruled by short-termism it may fail to reconcile stakeholder interests, educate and plan for the long term, eventually letting voters down. Incredible as it may sound, Plato, who lived in the world’s first real democracy, distrusted popular vote, favouring an idealised form of aristocratic oligarchy instead. Cicero saw his world oscillate between dictatorship and ochlocracy, democracy and republic, from one populist to the next, until finally emperors ruled Rome. The lesson from his time was than once populism takes hold, it is a slippery slope and a very bumpy road that ends in autocracy.
The social pendulum is swinging again. Already, American voters have more admiration for strongmen, like Mr. Putin, or indeed Mr. Trump. A recent poll by Gallup said that 22% of Americans had a favorable view of President Putin, up from 13% in 2015 and that was after allegations about interference with the Presidential election had become public. European voters lend more than an ear to less-than-tolerant policies and politicians.
Markets are very happy for central bankers to unilaterally take decisions that affect billions and are fearful of changes in the status quo. Some economists are becoming more convinced that a Chinese-type economic model may be the way of the future, as democracy breeds gridlock and thus loss of competitiveness.
This is folly in the long term. Democracy, or some sort of Republican regime, has been the bedrock of modern industrialized Western society. Even as some look to China for example, it must be acknowledged that corruption, lack of information, mismanagement and lower efficiencies are endemic in the country’s corporations, which is why they merit far lower valuations than their western counterparts. Darren Acemoglu’s seminal work “Why Nations Fail” indicates that economic prosperity is concomitant with healthy political institutions, with democratic liberties that allow free enterprise, movement of goods and people. When they are curbed, lives change. What will happen to Bombardier after the US government slapped 220% tariffs on their exports? What will happen to British small exporters that can’t set up shop in Europe, should a cliff-edge Brexit materialise? Markets have been happy to ignore political shifts that they perceive to be mere hiccups in the inexorable course towards globalisation.
The biggest current, and largely unacknowledged, risk for markets is a breakdown of the political status quo, same as the previously unfathomable break down of the financial status quo in 2008. Bringing down the system is indeed a very difficult task, which so far, populists have been thankfully unsuccessful. In Greece, the populist Syriza government was soon persuaded to see things from the creditor’s point of view. Donald Trump is fighting, but even the most powerful man in the world failed to pass legislation which could significantly alter the way America works. Marine Le Pen, Geert Wilders and other populists are still far from taking office.
So the markets a right not to worry yet. The centre still holds. But if we don’t see solid signs of markets allocating assets more efficiently and in a more equitable fashion, social tensions will only rise. If free markets remain reticent to challenge the status quo, and back more innovation and investment, someone else will. The more that try, the better the chances someone will succeed. No sooner than Europe breathed easily after Mr. Macron’s election and the recapitalisation of the Italian banks, than it was faced with a fresh wave of challenges, by the German AfD (and possibly the Liberal Democrats), Sebastian Kurtz’s rise in Austria, the Catalonian referendum and the possibility of another Eurosceptic government in the Czech Republic. “You think that a wall as solid as the earth separates civilization from barbarism. I tell you the division is a thread, a sheet of glass. A touch here, a push there, and you bring back the reign of Saturn” John Buchan once wrote.
Asset allocators are still justified to focus on economic and earnings fundamentals which are the best post-2008, propelling stock market levels at all-time highs. Monetary easing might not be panacea but it has helped cover a lot of problems. Long term investors, however, should be mindful of political inflection points, and behavioural influences to the economy, and ask themselves constantly at any event: Does this change economic fundamentals? Are we reaching a breaking point? So long as the answer is “No”, risks remain in the realm of theory. If it becomes “Yes” just taking about “binary risks” may not be enough.
Fears and Flows 