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September 2023



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Another respected punter warns of an impending global market “inflection”:

For decades, portfolio managers around the WORLD would receive the periodic “Economics & Policy” newsletter, full of original insights on everything from the markets, to the economy, to geopolitics, as penned by Stephen Lewis, chief economist at ADM (if best known for his tenure at Monument Securities which was eventually absorbed by ADM). Sadly, on Friday Lewis sent out his “Valediction” – the last ever Economic Insights report. Instead of commenting on it, we present his full thoughts in their original form as this particular career epilogue, a scathing critique of capital markets, modern economists, central bankers, and everything else that is broken in today’s society, is a must read for all market participants, as well as economists, politicians and central bankers.

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Economics & Policy


By Stephen Lewis of ADM Investor Services International

After more than forty-seven years spent observing and commenting on economies and financial markets, I shall be retiring this week to eke out my remaining days, as is fitting, in contemplation of the eternal verities.

When I  set  out  in  the  markets, on 5 January 1970, the yields on sterling bonds, including  those  issued  by  the  UK government (gilt-edged),  were expressed  in  pounds,  shillings  and  pence. One of the first tasks to which I was put, when I joined the stockbroking firm of Phillips & Drew, was to convert these yields into the decimal form with which our computer, fully occupying the building on the opposite side of the street, could cope.  Back then, the London clearing banks were required to hold in cash an amount equivalent to at least 8% of their deposits and 28% in liquid assets (cash, money at call and Treasury and commercial bills). There was not much risk of a bank liquidity crisis in those days. International asset diversification for UK-based investors was impeded by capital controls, with returns subject to variations in the premium on scarce investment currency as much as in the underlying prices of the assets held. For all the restrictions, though, octogenarians commonly travelled into their offices in the City each working day primarily for the fun of it.  It was a different world, unimaginable to those too young to have known it.  When told that we worked at our desks in candlelight during the power cuts of the three-day week in 1973-74, they naturally find it hard to comprehend what it was that we could possibly have been doing, so dependent have we lately become on electricity.

Since 1970, there have been nine UK prime ministers, thirteen Chancellors of the Exchequer, nine US Presidents, seven Chairs of the Federal Reserve and six Governors of the Bank of England; central bankers tend to stick around. Through most of this period, the trend was towards more liberal economic and social conditions, though latterly a reaction seems to have been setting in under the label of ‘populism’.  While there are vested interests still championing the liberalising process, the election of  President Trump shook the confidence of those who had believed that the ‘end of history’ had come with the fall of the Berlin Wall. It no longer seems inevitable that the future will bring ever more globalisation under the banner of the peculiar set of liberal values developed in the USA during the late twentieth-century. 

However that may be, after almost a half-century of analysis, there are certain conclusions I would draw.

What stands out is the failure of economics, as an intellectual discipline, to come to grips with the real world.  This was obvious at the time of the global financial crisis of 2007-09.  Since then, academic economists have worked on the assumption that their lamentable performance when it came to  warning  of impending troubles has been forgotten,  or  else  they hope the world at large believes they have so refined their understanding that there could be no recurrence of that debacle.  But they have not subjected their ‘science’ to the root and branch criticism that is clearly called for. As they argue whether they have enough Greek  letters in their equations, events take their own course. A particular weakness in economic analysis arises from the tendency of economists to regard these letters as signifying objective entities. Yet to proceed in this way is to overlook the difficulties attaching to the collection of relevant data. There are problems, not only of the familiar kind relating to proper sampling and timeliness, but of a more fundamental nature. We are not entitled to assume that the concepts favoured by economists in their analyses – consumption, investment, etc. – refer to clearly-delineated objective realities that are important in a causal  explanation  of  economic  events. After all, whether an item of expenditure is to be classed as consumption or investment is, to an unsettling degree, a matter of convention. 

The sadness is that central bankers, in moving to an almost exclusively macro-economic focus in conducting monetary policy, have paid increasing attention to the prescriptions of these self-styled ‘scientists’ of the economy.  Virtually all central banks now subscribe to the frankly weird view that economies cannot grow satisfactorily unless they maintain a 2% rate of arbitrarily- defined consumer price inflation.  This is despite the evidence in this and earlier ages that economies can grow quite well in the absence  of  such  inflationary  price  behaviour  (after  all,  the  2%  target  implies  a  doubling  of the price-level every  thirty-five years).  Thus, we are presented with the spectacle of central banks seeking to pump up demand, even when labour markets are tighter than they have been for decades past. The argument  is  that, without  the  prospect  of  higher  prices  in  the  future, consumption and investment spending would both die away.  But that is not how human psychology works. It may well be that investors’ demand for financial assets depends on the outlook for asset prices but consumers and businesses view the markets in goods and services in a different way.  They must do so, or else it would never be possible to launch new products where prices start high but then decline, reflecting economies of scale.

Central banks have come round to accepting the view, first expressed by Milton Friedman, that inflation is always and everywhere a monetary phenomenon.  But this view is misleading. Friedman based his dictum on his reading of history. Money supply and nominal GDP seemed to be broadly correlated. A more precise statement of the underlying relationship is that inflation occurs when central banks accommodate inflationary forces that usually arise from non-monetary economic and social factors. Mr Bernanke, drew the conclusion from his broadly Friedmanite analysis of the Depression years, that monetary policy could prevent deflation, which he understood to mean falling consumer prices over however short a term. Consequently, he led the world into the most extreme policy of monetary  accommodation since the invention of money. The longer-term consequences of the resulting misallocation of capital have still to be seen. In any  case, the efforts of central  banks in the advanced economies to push consumer price inflation up to a sustained 2% pace have so far proved futile.  A 2% inflation rate,  incorporating the hedonic adjustments that the statisticians have adopted over the past twenty years, seems to be above the sustainable rate in current economic conditions. There was a time when central banks needed these adjustments if they were to achieve a published inflation rate as low as 2% but recently the statistical tricks have contributed to the monetary authorities’ embarrassment in continually falling short of their inflation targets.

It is telling that the theory on which central bank policies are now based should have assimilated the behaviour of all economic agents to that of the financial markets. This has been part of  the move away from output and employment as the goals of economic activity towards the generation of financial returns within a short-term  perspective. It is consistent with the development of ‘financial capitalism’, from the 1975 May Day reforms on Wall Street, through London’s ‘Big Bang’ in 1986 to the massive growth in financial instruments in the early years of this century. The academic tide ran, not altogether surprisingly, in a direction favourable to the interests benefiting most from this development of the capitalist economic model. While academic economists whiled away their time refining their mathematical  expressions, the past few decades were witnessing a major shift in political thinking about the economy.  Whereas in 1970 a compromise had been reached between capitalism and government regulation that accorded government a role, albeit limited, in managing markets and the economy, this broke down in face of the mounting strength of market forces and after continual disappointment with economic growth and inflation control.

The first crack came with President Nixon’s ‘closing of the gold window’ on 15 August 1971. This action, which marked the end of the fixed exchange rates that had, for the most part, prevailed up to that time, was arguably the most momentous event in economic policymaking of the past half-century.  In fact, on the day, it caused remarkably little stir in the London markets, only a sense of puzzlement.  This may well have reflected London’s isolation from international developments, stemming from  the very  strict UK exchange control regime in  force  at  that time. But with the advent of the Thatcher and Reagan administrations, free-market ideology was clearly in the ascendant.

The intellectual argument in favour of free markets, as against rigged markets and government intervention, is compelling. However, anyone who has been involved in markets will be aware that they are never perfectly free and fair to all participants. Instead of accepting uncritically the virtues of free markets and indiscriminately breaking down barriers and safeguards, policymakers would have been better employed addressing the dangers posed by the ‘free’ markets as they were developing. This was the lesson of the 2007-09 financial turmoil but it is a lesson that, by and large, has not been heeded.  The post-2008 growth in global credit massively raises the risk of a future crisis, despite official measures requiring more stringent bank capital requirements. Even these strengthened defences would prove flimsy in the event of any future collapse in confidence, a collapse that is all too likely to occur in view of the aforementioned misallocation of capital.

The promoters of free markets are wont to appeal to Adam Smith as their authority. This Enlightenment philosopher has suffered a similar fate to such luminaries as J M Keynes and Karl Marx, in that his followers have presented a distorted view of his insights. The ‘free marketeers’ focus on Smith’s work The Wealth of Nations without paying heed to the ethical presuppositions underlying that analysis.  His assumptions were derived from Hutcheson’s moral philosophy and are set out in his earlier publication, The Theory of Moral Sentiments, a work that is usually ignored or denigrated by Smith’s modern-day adherents. To be sure, his view of human nature, as there set out, is rather benign. He makes no allowance for the cheating and exploitation that characterise behaviour in actual market situations. His failure to understand, or at least to recognise, the moral failings of his fellow-men diminishes the value of his economic analysis as a guide to action.

Free markets have gone hand in hand with globalisation, the strengthening power of transnational commercial interests relative to that of national governments.  At the same time, in the advanced economies, there has been a growing sense among the many that a few are making off with the fruits of economic progress. These developments are probably connected. 

The positive function of the nation-state is to maintain equity between the social classes. The nation-state is the largest unit that can feasibly fulfill this function. I realised something was going badly wrong several years ago when a respected British fund manager said that he felt he had more in common with a banker in Frankfurt than with a factory-worker in Birmingham. The nation-state was no longer fostering a sense that we were all in it together.  The subsequent social tensions and rise of populism were no surprise.  In 1970, the UK ruling elite was seeking to dissolve national sovereignty in a broader European entity.  In view of the unhappy record of subsequent UK-European relations, the 1973 accession to the EEC is likely to be judged a historic mistake.  I had not expected to see the day when that decision would be reversed.  But Mrs May and her advisers seem to understand the crucial importance of the nation-state in preserving social justice.  If they have a chance of living up to their words, the UK may well become a beacon to the world.

With that thought, I shall lay down my pen and depart in peace.

End of quote.

Eerily aligned with the prognostications of Jim Rickards.


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