Biden’s Squandered Opportunity

Winston Churchill is said to have remarked that one should never miss the opportunity lurking behind a disaster. Perhaps, hopefully, we are missing something… but Saturday night’s Iranian attack on Israel could have been a golden opportunity for the US alliance to hit back at Iran strongly and at a minimum dial back Iran’s nuclear program for several years, or ideally, eventually provoke a regime change.

Different from say the Gazans, who overwhelmingly supported Hamas, at least until their cities became scorched earth, the Iranian people by and large do not support Teheran’s regime. Over the last decade, many grassroot Iranian groups have tried to challenge their bloodthirsty government and have pleaded for the United States to support them. A strong combined attack on Iran’s infrastructure and nuclear weapons program could have provided the ideal catalyst for a popular movement that wants to overthrow the Mullas’ regime. But instead of grabbing the opportunity that Iran served on a silver plate, Biden and his administration didn’t waste time to ask Israel not to respond. “Take a Win” is what Biden reportedly told Netanyahu.

True, the coalition that worked so effectively alongside the IDF to thwart Iran’s aggression is a win. But wars are not won only by defending well. At the right time, the opportunity must be grabbed to inflict serious damage on Iran and decapitate the octopus that is sowing terror, and war in the entire middle east. Biden is a key friend of Ukraine, doesn’t he know that Iran is supplying the drones that Russia is using against Ukraine? Doesn’t he know that Iran is a key player in the axis of evil that includes Russia, China, North Korea?

Does he really want to wait until Iran tests a nuclear weapon, thereby making it a lot more difficult to deal with? Didn’t he learn the lessons of history, that tyrants won’t get appeased?

What a colossal failure of judgment.

Who is Beating Inflation?

Due to a consequence of mistakes in fiscal and monetary policies, inflation in 2022 has jumped to levels not seen in decades in the western world. The good news is, US inflation now seems to be heading back down to 3%, the UK has broken through the 8% barrier, while Europe is still hovering around 5.5%.

As the US always leads in most things, one should expect both the UK and the Euro area inflation to slowly trend back down to the ranges that policy makers like by year-end. Therefore, two questions beckon. Have we beaten inflation? And if so, who beat inflation?

The answer to the first question is that we need to see a few more readings to be sure that inflation has been tamed.

The answer to the second question is more interesting. We need to look at the causes of inflation. In the last three years, the world has witnessed unprecedented disruption due to the war in Ukraine, and the effects of Covid-19 which forced governments around the world to lock people at home and pay supplemental income to those who lost their jobs or simply couldn’t ‘work from home’. Governments that prevented people from working had to take on the responsibility of paying them, and this was done both indirectly, by helping companies and directly, individuals.

The problem was that governments made a dosage mistake. Most people in the developed world, especially the relatively affluent young professionals, tend to spend an important portion of their income on entertainment, eating out, and travel. Due to long lockdown periods, the supplemental income that people received, that was not spent, increased savings. These savings were initially invested in stock markets, cryptocurrencies, watches and the like. But then, as the world reopened, pent up demand for travel, restaurants, and entertainment resulted in a flood of money into a plethora of services, that were themselves facing supply shortages in every aspect imaginable while they ramped up their capacities. Scarcity of service staff at restaurants, handlers at airports and the inability to refill old positions due to people moving for various reasons during the long lockdown period lead to higher costs in the aftermath of the lockdowns. And to compound policy errors, as soon as he got elected, Biden decided to give more money to more people in an unprecedented stimulus package while the effects of Covid-19 were subsiding, in a move that most economists thought was a colossal fiscal policy error.

The result: low supply of goods and services, high savings, new stimulus, and pent-up demand, high inflation. Prices moved up, and if history is an indicator, they will not really come down. There has been a parallel shift in the curve but inflation is not a measure of price levels, it is a measure of acceleration. Just like getting sucked in to your seat on a plane during take-off at 250MPH but not feeling anything when it stabilises at 550MPH, what is felt is acceleration, not the static higher levels of speed.

Monetary authorities, who were asleep at the wheel when inflation started moving up and were still priming the economy with low rates and quantitative easing (remember QE? Simply put, buying bonds and increasing money supply), had to catch up rapidly and deliver nearly constant monthly interest rate increases that have brought short-term rates around the world from around zero to the 4-6% band.

The question to ponder is, was it higher rates that was taming inflation? If inflation went up because of a supply and demand mismatch that has since subsided, perhaps inflation too has now stabilised after moving the prices higher. This would mean that this stability has less to do with higher rates and is more a result of the absence of the reasons that brought it up in the first place. Or alternatively, we have entered a price-wage spiral reminiscent of the ‘70s that will take much longer to cure.

The next few months will tell. In the meantime, medium-term low risk bonds could be a bargain in either scenario.

The First Bailout is the Cheapest….

What if …. on that infamous September week in 2008, the Fed decided to do for Lehman what the Swiss Central has announced tonight in connection with Credit Suisse, namely announce a backstop, if necessary. History probably would have been very different.

Lehman wasn’t a basket case, it had a liquidity problem deriving, among other mistakes, from a funding mismatch. If given the time, it would have probably been able to weather the storm. But at the time the Administration and the Fed decided, for multiple reasons, to look away and let them file for Chapter 11. The chaos that ensued forced the Fed and the US authorities to have to spend trillions to save the US banking system. The Fed had to cut rates to near zero and to embark on a quantitative easing program that lasted a decade.

This incredible avalanche of cheap money had soothing but also long-term negative effects by distorting the capital markets’ usual functioning and bringing rates down to negative in many countries around the world.

Negative rates adversely affected savers, gave huge headaches to insurance companies whose liability matching was made nearly impossible. It also led to super high equity markets whose valuations are also a function of the discount rate.

Then came Covid-19 and the unprecedented stimulus that President Biden bestowed upon Americans at a time when it was probably not needed anymore, at least in that magnitude. That, coupled with other exogenous factors (spike in energy costs, stressed supply chains, war…) stoked inflation to forty year highs.

To combat inflation, the Fed starting to reverse course, late, and therefore even more abruptly, with consecutive 50 and 75bps hikes that brought rates higher by nearly 500 bps in less than one year. And this is now the cause of the current crisis, the bank crisis.

Usually, banks tend to do well in times of higher interest rates because they are more efficient at managing their treasury than their clients at managing theirs. Money kept on current accounts or in low yielding deposits can be placed in loans, bonds, and deposits with other institutions at higher rates. And, in fact until just over a week ago, the banking sector seemed to be doing just fine. But under the apparent calm, another big problem was brewing, asset liability mismatching, or a reverse Lehman problem, to turn full circle.

SVB collapsed for a very simple reason. When its clients, inundated them with cash they received from tech investors and PE funds deposited their funds with SVB, the bank had to deploy this cash, and typically banks will buy safe government bonds, as a preferred part of their investment portfolio. Usually government bonds are relatively safe, except that bonds’ performance are a factor of two components, credit risk and interest rate risk. Credit risk is by definition low (or zero) for US Government bonds, but the interest rate risk component blew up in historic proportions in the last ten months. As bonds decline when prevailing interest rates rise, banks such as SVB, and many others, found that the mark to market value of their bonds had declined by possibly over ten percent. However, certain accounting rules allow banks to report the value of their bonds as they will be worth at maturity, and at maturity bonds go back to par. On the liability side of the balance sheet, as prevailing money market rates started to go up and investors time deposits rolled, SVB had to pay increasingly higher coupons to its clients, whilst being stuck with fixed rate assets now (temporarily) underwater. Once client started to smell this mismatch, they started pulling money out and created the proverbial bank run. This same scenario is playing out in many variations at lenders across the world.

One policy mistake fifteen years ago is reverberating across the markets leading to more mistakes, more corrections, more bailouts, more pain. When will it end?

“Reverse” Sanctions?

President Biden has been credited in the media and in democratic circles for having responded swiftly and effectively to Russia’s invasion of Ukraine.  While it is true that the sanctions plan that his administration has orchestrated against Russia was one of the few available arrows in his quiver that didn’t risk a wider conflict, it is becoming quite apparent that the sanctions are not effective, or at least not as intended.

A few weeks after the start of the war Biden boasted that “sanctions are working”, with the ruble in free fall worth not much more than an American penny. However, six months later, the ruble has more than doubled in value since mid-March and is now worth more (61 to the Dollar) than it was worth before the war (83 for one Dollar). In addition, Russia’s income on its Crude and Gas exports are higher than before, with a lower level of sales more than compensated by higher prices. If Russia were a corporation, it would be having a great quarter, with stable income and a fraction of Cost of Goods Sold.

So who is suffering from these sanctions? Very simple: Europe. While one should remember that Europe’s ills are mainly of its own making, with a disastrous energy policy that relied on Russia being their friend forever, it doesn’t take a sophisticated econometric model to understand that in the zero sum game of trade economics, Russia is not losing, rather it is actually winning, while European consumers and factories have to pay for its gas up to ten times the cost of last year. This is ravaging energy-heavy industries such as steel and ceramics for example, and in a way all heavy industry which is dependent on energy. We are now hearing of factories in the continent that will not reopen after the August break, as in many industries production cost is now higher than prices. Producing means losing money. If this vicious circle is not corrected, look for industrial production to take a nosedive in the fall, with all the economic and social consequences. Requests for layoffs are already being made.

The sanctions on Russia have become sanctions on Europe. There may not be a quick fix, but it is obvious that Biden’s sanctions have failed miserably. Time for a change, before the European united front fractures and populist parties gain.

Mario Draghi: The silver lining in his departure

Most reasonable international observers were mystified by the circumstances that led to the end of the Draghi government. Having achieved so much in only eighteen months, and with only 9 months to the natural end of the legislature, one cannot help but wonder why the Italian parties and parliament have decided to vote against the will of the majority of Italians, not to mention Western leaders, to cut short this incredible government. During the last 552 days, Mario Draghi, Italy’s thirtieth Prime Minister since World War II has achieved targets that have eluded most of his predecessors:

– He was instrumental in the implementation for Italy of the European Recovery plan, which awarded Italy one of the largest allocations in Europe, in return for a package of reforms;

– All the required reforms were delivered on time until now;

– These actions have initiated a virtuous circle of investment and increases in productivity that will last a generation;

– He presided over a 6.6% rise in GDP, among the best results in Europe after the Covid recession;

– This helped to reduce the widely watched Debt/GDP ratio by 4.5%;

– He was easily the most respected Italian leader of the last forty years, responsible for coordinating the West’s response to Russia’s aggression, and visibly part of Europe’s top leadership together with France and Germany;

– He quickly acted to replace Italy’s dependence on Russian gas by striking deals with north African and middle eastern countries.

But the list of necessary reforms is not finished. Draghi wanted to complete his tenure by also achieving long lasting changes to increase competition, restructure the Tax Code, and make welfare payments more efficient. Had Draghi not resigned, most of these reforms would have been part of the 2023 Budget, but achieving them on the eve of the national election campaign would not have been easy.

The decision is now going to go back, democratically, to the voters. If the ‘Draghi effect’ continues, his Agenda will be adopted by a government that will have the votes in parliament to back a decisive 2023 budget without having to worry about elections on the horizon. With the populist left in shambles, the risk is now that the populist right will win the elections and seek to undo Draghi’s work. But the fact that most of the parties that caused the fall of his government have already splintered into groups that have committed to back the Draghi agenda, gives cause for cautious optimism that the foundations he laid in the last 18 months will constitute a structural change in the Italian economy that will last for decades to come.

Italy’s revival despite its moribund airline…

Italy has generally taken good advantage from the Covid-19 tourism hiatus, to develop new world class hotels, refurbish aged ones, build new airport terminals and more. Milan’s city airport Linate has been upgraded and it is a pleasure to spend some time in it between flights. Rome’s Fiumicino airport has become a world class hub with state-of-the-art facilities, full wall LCD screens everywhere, tasteful design, real high-quality malls with the best global designers and brands. In short, an apt window into what Italy is best at, design, fashion, and good taste.

Rome’s aging hotel stock is also being upgraded and complemented with global and local brands which are attracting well-heeled tourists from around the world. This is in addition to a reborn short-term letting industry which has suffered during the pandemic but seems to be emerging stronger than ever. Away from Rome and Milan, “new” beautiful tourist destinations have also gone international, imagine places such as Puglia and Forte dei Marmi, which were traditionally domestic destinations, and are now boasting world class hotels with an increasingly jet setting international clientele.

The remaining black mark for Italy is unfortunately in its national visiting card—its flag airline, Ita Airways (PKA Alitalia). Despite uncounted billions of euros of government investment during the last two decades, Alitalia was always on the brink financially, and barely acceptable from a passenger experience point of view. Last year, after the umpteenth auction to sell it to private equity or to a global competitor failed, the state was forced to buy it and recapitalise it by letting Alitalia close down and setting up a ‘new Alitalia’, Ita Airways that effectively acquired its planes, slots, and most of its employees. Nine months into the process, very little seems to have changed, starting from the planes, most of which are still painted Alitalia, even though there is a growing number that have been repainted with Ita’s livery at a cost of $50,000 a plane. Aside from this, the airline is setting new lows for client service. To get a glimpse you can check online reviews, which give it an average of 2/5 on most categories.

While nations can thrive without a national carrier, one would think that if you have one, it has to adequately represent its host nation. Emirates had a big role in promoting Dubai as both a hub and a destination in its own right. Alitalia/Ita is today a poor window into an Italy that is turning around, a mediocre low-cost carrier with a major airline ambition and cost base. On a recent trip in business class, I was one of three passengers in a class that can carry 16, and the reasons are obvious… the seat configuration, not to speak of the service are simply inadmissible in today’s competitive marketplace.

The airline seems to be up for sale again…Let’s hope that it can find a suitable buyer that will either upgrade it to a national pride or downgrade it to an efficient low cost. The middle seat is untenable as well as uncomfortable.

Long Vaccine…

Nearly 18 months later, we are beginning to see some  patterns in Covid-19 which should help health and policy planners to manage what is becoming an Endemic disease, in the words of the Economist.

One of the interesting patterns is that the Vaccines work on a FIFO basis, in accounting jargon—ie First in, First out.

The most virtuous countries who vaccinated super early such as for example, Israel and the UK have seen a deterioration of the number of daily cases in the last few months, going back nearly to all time highs. Israel which was the global lab for Pfizer went from 10,000 daily cases in February to below 100 in May and then back to 10,000 in the summer. At that point, the country trailblazed again with the quick adoption of the booster, and numbers are now back down to several hundred per day.

In the UK a similar but not identical phenomenon is taking place. As an early adopter, most UK residents are beginning to count six months from the second dose, and daily case numbers are spiralling. But there is a big difference, whereas in the spring 40,000 daily cases meant nearly 1500 deaths, today the same amount of cases amount to ‘only’ 150 daily deaths.

Perhaps we can learn as follows: firstly, vaccines seem to give a medium to long -term protection from serious illness and death; however, protection from catching the disease only lasts up to six months. Israel is going for eradication of daily cases via the booster, the green passport, and the usual distancing rules, which keep on being prevalent. The UK seems to have decided that the booster is enough to manage the epidemic, without resorting back to any restriction. The one issue it has is that in order to make people take the booster, there has to be some ‘get out of jail’ incentive and the one that has worked better in most countries (eg France) is the vaccine/green passport. For ideological reasons (UK citizens don’t even need to have an ID card…) Boris Johnson is resisting this and therefore he has to cope with slow booster take-up and high daily cases, which it can stomach until the NHS copes and daily deaths are ‘acceptably’ low.

The coming winter months will test both these conclusions.

Why shouldn’t we call a spade a spade? This is Biden’s Saigon Moment

There is one key difference here. Biden is (D) and is supported by a left-wing democratic party. True, the decision to withdraw was initiated by President Trump. It was a bad idea under Trump, and it has become a national disgrace under Biden. The incumbent cannot blame his predecessor here, this is not a policy that takes months or years to reverse, like many in economic policy. In his first day in office Biden reversed with the stroke of a hand many Trump policies and he could easily have ordered a reappraisal of why and how to leave Afghanistan.

Twenty years after 9/11, after investing (squandering?) over 2 Trillion dollars and thousands of lives of its servicemen and contractors, the US is leaving Afghanistan, less than emptyhanded, humiliated and with its reputation in tatters.

As the Taliban conquer the presidential palace, and the US send helicopters to evacuate its embassy, the memories of Vietnam become vivid. If there was a Republican at the white house, the media would have crucified the president presiding over this terrible precedent that the US is showing to allies and foes. One could argue that in recent years the Afghanistan campaign was highly successful in terms of costs vs benefits. The US only had less than 3,000 troops in Afghanistan, and hasn’t suffered a human loss in about a year and a half. In life it is usually not prudent to throw good money after bad, but protecting one’s investment on the cheap seemed the better strategy here…

Toxic Cocktails

The combination of Covid-19 and Brexit have turned back the clock on the traveling smoothly by 70 years.

Until 2019, frequent and not so frequent travellers used to take for granted that they could whisk in and out of their countries without ever speaking again to a border agent. E-gates had become the norm, at least in European countries.

Travelling now in 2021 is more akin to dodging landmines. Every week states come out with new and more complex regulations, including paper based and digital forms, first pioneered by the UK and now imitated by EU states. The PLF (Passenger Locator Form) has become a dPLF in the EU; however, not all European countries demand it, yet, and there doesn’t appear to be a site that informs passengers which countries do or don’t ask for it.

Travelling on the Eurostar between Paris and London and vice versa has the added complication of Brexit. Travellers going from Paris to London will have to have their travel documents checked four or even five times before they get on the train. They will have to come up with a good reason to leave France, and a better one to go back to the UK. Once they reach the UK, they will see a barrage of customs/border police officers looking for….? Given that all passengers are already checked at the Paris UK Border Police booth, what is the need for the extra scrutiny in London?

The same is true for the opposite direction of travel. Travellers landing at la Gare du Nord will see a dozen French customs agents scrutinising their faces and luggage looking for…?

If all of this is not enough, the French authorities have just announced that they will require travellers from the UK to isolate for a week; however, they are also told that nobody will bother to come and check. The UK of course does the same thing (but there they do check with ‘volunteers’ that look like Uber drivers that visit your house at random) as France is of course, an Amber country.

I have a simple question. Why does a traveller from France need to be checked five times when a traveller from Colombia will get away with one or two? What incredible extra danger do these Eurostar travellers present that they should be scrutinised to such an infuriating degree?

It is possible that a lot of these extra doses of attention are actually needed to prevent Claret coming back into the UK or the Indian variant to contaminate Europe…. but this degree of zeal smacks a lot like a political tit for tat. The French and the English have had periods of tolerance and periods of mutual antipathy, you can guess what is today’s direction of travel…

When Too Much Thrift is No Good

What is the most common sin of elected officials? You guessed it. Taking advantage of their position to gain private benefits. The London political scene has been up in arms with two ‘scandals’ in the past months, both of them probably more political than legal. The first was David Cameron’s lobbying for a failed financial group, long after his full exit from public life, but ostensibly using connections he gained while he was prime minister. The latest stems from Boris Johnson’s spending a very modest amount of money to upgrade his living quarters at 10 Downing Street. The allegation is not that he used taxpayer money improperly, but rather that the refurbishment was paid by friends, in contravention of election rules. Where is the honour of the office, for the man responsible for the security and health of 60m Britons? Ah, that is only for the Royals, whose closest life and death decisions are whether to kill or spare the next goose at Balmoral…

This case is similar, if simpler, to Benjamin Netanyahu’s legal travails in several criminal cases opened against him. The cases range from receiving cigars from businessmen, to asking for Champagne, to requesting good (fair?) media treatment in a country where, much like the US, the media is in the hands of the left-wing liberals.

It seems that there is a much cheaper, more efficient, and fair way to deal with these ‘mini-sleaze’ issues: afford prime ministers compensation and benefits that reflect the importance and honour of their office, not because they should gain a luxurious lifestyle at the expense of the taxpayers, but much more pragmatically because if they can afford to pay for furniture and cigars, they won’t have to ask favours, which have a tendency to be called at some point.

Countries like the United States, but even revolutionary France, and of course Putin’s Russia, treat their senior leaders much more lavishly. They don’t need to spend their pocket money in doing up their living quarters, as this is done at the expense of the State. Just like the queen, the President has attendants that take care of his every need, including helping him to dress in the morning! Contrast this to the British prime minister who has to cook his own dinner, or to the Israeli prime minister who has to rent an El Al plane to travel for State trips (a new plane has finally been ordered), and has to sit on a public beach if he wants to go on vacation (unless he has his own funds of course).

And when things go wrong and these leaders face legal action? They have to spend their own money and time to defend them while in office.  Mr. Netanyahu is responsible for the safety of nearly 10m Israelis who live under the shadow of missiles, terrorism, cyber threats, nuclear bombs, and more recently, Covid of course, but he has to spend incredible time, concentration, and resources in defending himself in court. Contrast this with the United States, where the president can only be indicted for high crimes and treason, and even that is a political exercise which takes a couple of months, not many years, as we have recently witnessed. Or consider the French system, where sitting presidents cannot be indicted for crimes until their term is up, as it happened recently with Chirac and Sarkozy.

Our leaders’ time and attention are priceless. One hour flight time of an F-15 can pay for a lifetime of cigars, champagne and sofas. Let’s pay our leaders fairly and generously and then expect full attention and no conflicts of interest.